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“If you build it, they will come.”
That has been the tried-and-true mantra of commercial real estate developers—but in recent years, the opposite has been true. People come, and developers build. Demand is flourishing, and in many product types, developers are hurrying to keep up. The dynamic is driving ample new construction activity across the country. Last year, total construction spending peaked at $1.6 trillion, 12% above 2019 activity, and this year, 91% of construction professionals are optimistic that activity will grow.
This voracious construction activity, however, is happening in unexpected markets. The pandemic catalyzed a mass migration from major metros to smaller cities and the suburbs. As a result, the new construction activity is most significant in a string of growth markets, particularly in the Sun Belt and Southern regions.
Emerging Markets Take the Lead
The list of top commercial real estate markets looks a little different than it might have just five years ago. In place of major metropolitans and gateway markets, smaller cities like Austin, Atlanta, Phoenix, Charlotte, Raleigh and Nashville are now the country's top commercial real estate markets. In a 2022 construction industry survey from Wells Fargo, contractors were the most optimistic about development in the Southern region, home to the majority of these emerging markets.
A perfect storm of population growth and corporate expansions and relocations is driving the growth, prompting a wave of new construction activity in these markets. Austin, one of the hottest growth markets in the country, is now home to an impressive roster of major tech companies like Google, Tesla, Facebook and Samsung. With the expectation that the city’s population will grow 25% in the next ten years, Austin is ranked ninth in the US on CBRE’s development opportunity index, which measures market conditions that support new commercial construction activity, and in the top 10 on the indexes for multifamily, retail and office construction.
Charlotte is another standout market for population and job growth. Rather than tech jobs, Charlotte is a hub for financial institutions like Wells Fargo and Bank of America. Like Austin, the city is one of the leading markets for new multifamily and retail supply since 2010. Other cities that top those development indexes are San Antonio, Nashville and Raleigh, illustrating the swell of development in small metros.
Development activity in these markets is expanding quickly to keep up with demand. The Deloitte 2022 Real Estate Outlook survey found that 40% of respondents planned to revive suburban development activity and more than half of respondents are expanding development projects in emerging markets, saying that the opportunity to work remotely combined with new geographical preferences made these markets “even more lucrative.”
Population growth in that list of top growth markets is creating opportunities for new development across asset classes, but new housing is in most immediate need. This year, about 400,000 new rental housing units will deliver nationally, and 25% of those units will deliver in just six markets in the Sun Belt region—Austin, Phoenix, Nashville, Atlanta as well as Houston and Dallas-Fort Worth. According to data from Marcus & Millichap, these six markets are also experiencing an influx of new people with a total of 250,000 new household formations expected this year alone.
Despite the ample new housing construction in these markets, rental rates have continued to climb, one sign that supply is not keeping up with demand. Phoenix is leading the nation in multifamily rent growth. With record apartment absorption last year, rents increased 28% and home prices grew 22%. Other emerging markets are seeing equally impressive growth. Apartment rents in Austin climbed 25% after vacancy fell 300 basis points; Atlanta apartment rents are near double-digit growth at 9.8%; Nashville apartment vacancy fell to 2.4% with rents growing 9.1%; and Raleigh vacancy is at a low 2.7% with rents up 8% this year after growing 22% in 2021. This activity is in stark contrast to major metros which experienced significant rent loss during the pandemic and are only now starting to gain momentum this year after recovering in 2021.
Industrial development is also filling up construction pipelines in many of these markets. In Austin, 9.3 million square feet of new industrial space will be delivered into the market in 2022, more than the last three years combined. Austin is the top market for new industrial deliveries, but Phoenix, Las Vegas and Atlanta are also seeing marked construction, with inventory growing 17.2%, 11.6% and 10.5% this year, respectively.
While office, retail and hotel construction activity is less significant, there are still companies making moves in those sectors. Retail REIT KIMCO Realty, for example, merged with Weingarten Realty to strengthen its retail position in the Sun Belt and suburban markets.
Commercial Real Estate Construction Costs Are a Barrier
Although construction pipelines are hitting record levels in emerging markets, rising challenges could impede new construction activity. In June, new housing starts fell for the second straight month by more than 14%, while new building permits remained flat. The S&P Homebuilders Select Industry Index also fell, declining about 4%.
Rising interest rates are central to the struggle to break ground. In June, the Fed increased rates by 75 basis points, 25 basis points above expectations, and indicated additional aggressive rate hikes at subsequent meetings. But developers are also battling inflation, which has led to higher construction, material and labor costs, and supply chain issues, which are causing significant development delays and increasing carry costs.
It is a market dichotomy. These headwinds are evolving even as strong fundamentals are creating substantial opportunities for developers in new markets. Developers that are able to absorb the risk and manage higher development costs are best positioned to seize on construction prospects. Commercial real estate technology is the best way for developers to do both. Intelligent development management software like Northspyre can mitigate risk on new construction projects using automation, data and analytics and budget forecasting. It can account for these rising costs, delayed timelines and increased costs of capital to deliver more predictable outcomes on projects and keep developers competitive.
The road ahead may be bumpy, but there continues to be ample opportunity to bring new supply to growth markets across the country. For those able to manage these challenges, the development heyday will continue.
Tag(s): Real Estate Development
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