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By: Practical Guidance Real Estate, Construction, and Finance Attorney Teams
PRACTICAL GUIDANCE RECENTLY COMPLETED ITS ANNUAL PRIVATE MARKET DATA REAL ESTATE SURVEY. This survey, which ran from August 25 through September 30, 2023, asked nearly 80 real estate attorneys from across the country to identify trends in the real estate and construction markets based on their practice.
Analysis of the survey results by the Practical Guidance Real Estate, Construction, and Finance attorney teams uncovered a number of notable insights discussed below that practitioners should be aware of.
Even as demand for labor is falling across all US industries, the demand for construction labor remains higher than supply. (See Construction doubles number of new jobs in October compared with September.) Multiple factors are driving this shortage of workers. These include lingering fallout from COVID-19 disruptions, changes in the labor market and worker expectations, and an aging labor force. At the same time that workers are shying away from construction jobs, a rapid increase in construction following passage of the $1 trillion Infrastructure Investment and Jobs Act in 2021 has exacerbated the gulf between supply and demand.
Practical Guidance recently asked attorneys if labor shortages affected their construction clients in 2023 and a resounding 68% answered yes:
Moreover, when the 15% who reported that the question was not relevant to their practice are removed from the survey results, 81% of respondents reported that their clients have been affected by labor shortages.
Yet, many respondents see a light at the end of the tunnel. When asked about the outlook for 2024, a full 50% of those surveyed predicted that construction labor market conditions will improve and only 26% predicted that conditions will worsen, with 17% believing conditions will stay the same.
Labor shortages can cause significant delays in construction projects, triggering changes in work, claims, and even contract termination. For guidance on these issues, see Changes in Work and Claims Provisions in Construction Contracts and Termination and Suspension Clauses in Construction Contracts.
Project delays can also spur owners to seek liquidated damages from contractors. For guidance on liquidated damages, see Liquidated Damages Clauses in Construction Contracts.
For a full set of Practical Guidance construction resources, see Construction Resource Kit. For dispute resolution resources, see Construction Dispute Resolution Resource Kit.
Supply Chain Disruptions
In addition to labor shortages, the COVID-19 pandemic also spurred serious disruptions in the construction supply chain. In turn, these disruptions escalated costs and slowed project turnaround. To better understand whether these supply chain disruptions remain a factor for construction in the post-COVID world, Practical Guidance asked attorneys whether supply chain issues impacted their construction clients in 2023. A full 72% responded yes:
When the 9% of respondents who indicated the question was not applicable to their practice are removed from the survey results, 79% answered in the affirmative.
But, when asked about the outlook for 2024, more than half of respondents, 54%, predicted that things will improve, with 19% predicting they will worsen and 14% believing they will stay the same.
The COVID-19 pandemic and resulting supply chain disruptions have prompted construction attorneys to revisit and revamp their force majeure clauses. For guidance on drafting these clauses, see Force Majeure Clauses in Construction Contracts. For sample force majeure clauses, see Force Majeure Clause (Construction Contract).
Supply chain disruptions often drive up the costs of construction materials. To deal with these cost escalations, attorneys often include cost escalation clauses in their construction contracts. For a cost escalation clause that can be included in a fixed-price construction contract, see Cost Escalation Following Force Majeure Event Clause (Fixed-Price Construction Contract). For a guaranteed maximum price clause, see Guaranteed Maximum Price Clause. For a discussion of cost-escalation clauses in fixed-price and guaranteed maximum price contracts, see Negotiating Material Escalation In Construction Contracts.
For information on payment and pricing methods in construction, see Construction Contract Methods of Compensation and Payment and Construction Pricing Models: Choosing an Appropriate Pricing Arrangement.
For a complete set of Practical Guidance resources addressing the drafting and negotiation of construction contracts, see Owner and Contractor Agreement Resource Kit.
As employers transitioned to remote work during the pandemic, commercial landlords were left with record-high vacancy rates. Landlords in many markets across the country are continuing to feel the impact of the changing workplace. While more employers are now starting to require some degree of in-office or hybrid attendance, commercial vacancy rates remain high as tenants adjust their leases to meet their current space needs.
Practical Guidance asked attorneys if landlords are giving prospective commercial tenants incentives to sign commercial leases as the work-from-home trend continues. Sixty-eight percent of survey respondents said yes.
Incentives such as free rent and buildout allowances can help commercial landlords attract and retain tenants in this challenging market. With the leasing industry in flux, commercial landlords and their attorneys must keep an eye on the market and leverage the tools and their disposal to fill space. For further insight into COVID-19’s impact on commercial leasing, see Impact of the Pandemic on Commercial Property Occupancy and Valuation: Practical Strategies for Lawyers and Advisors. For a full listing of commercial leasing resources in Practical Guidance, see Office Leasing Resource Kit, Industrial leasing Resource Kit, Retail Leasing Resource Kit, and Subleasing Resource Kit.
In early 2023, a series of regional bank failures, including Silicon Valley Bank and Signature Bank, caused volatility throughout many sectors of the market and created concerns over further economic impact. Regional banks’ portfolios are composed of a significant portion of commercial real estate-backed loans. The collapse of some notable regional banks coupled with the continuing post-pandemic stressors on the valuation of commercial real estate has continued to negatively impact many aspects of the commercial real estate market. According to 68% of the survey respondents, the recent bank collapses have impacted the real estate industry.
The bank failures triggered fears of broader economic decline leading to less credit availability for the commercial real estate market and resulting in less investment and construction. The survey asked respondents to indicate the areas of the real estate industry that have been impacted by the bank collapses and to select all that applied among construction, acquisition loan financing, commercial purchases and sales, and joint ventures. Survey respondents indicated that acquisition loan financing has been impacted the most by the bank collapses, followed by commercial purchases and sales, and construction, along with some impact to joint ventures.
For additional information on bank failures and the commercial real estate market, see Bank Failure Resource Kit, 3 Ways SVB, Signature Failures Will Rattle Real Estate, and Troubled Hotel Properties On Shaky Ground As Debt Matures.
The increased regulations and capital requirements imposed on banks by Dodd-Frank and Basel III have resulted in less availability of commercial real estate financing by traditional bank lenders. Consequently, over time, non-bank lenders have become a significant source of commercial real estate loans. In addition to bank regulation, recent regional bank failures and rising interest rates have contributed to a marked increase in non-bank lending to the commercial real estate market. Since non-bank lenders are not subject to the same level of regulation as traditional bank lenders, non-bank lenders may offer more flexibility in loan terms, including advance rates, negative covenants, and interest rates.
The survey asked respondents approximately what percentage of commercial real estate financing they have seen coming from non-bank lenders in 2023. More than half of the survey respondents (60.75%) estimated that between 26% and 75% of commercial real estate financing in 2023 was provided by non-bank lenders.
Further, the survey asked whether the percentage of non-bank lender financing in 2023 seemed to represent an increase over 2022. A majority of the survey respondents (58%) indicated the amount of commercial real estate financing provided by non-banks in 2023 represented an increase over 2022.
Whether the increase in non-bank lenders providing commercial real estate financing will continue remains to be seen and depends on a number of factors that affect availability of commercial real estate financing and traditional bank lenders. Those in the real estate industry should continue to monitor banking regulations, regional bank stability, and interest rates, and consider commercial real estate loan default rates and property values, all of which will have influence on sources of commercial real estate financing.
For additional information on non-bank financing and commercial real estate financing generally, see Commercial Real Estate Acquisition Loan Resource Kit, Economic Growth, Regulatory Relief, and Consumer Protection Act: PART 1 – Impact on High Volatility Commercial Real Estate, Private Credit Loan Transactions, and Representing National Real Estate Lenders.
Building Efficiency and Decarbonization
Property owners and investors are increasingly considering energy efficiency and carbon reduction issues when purchasing real property. Energy efficiency measures can help reduce operating costs by lowering electricity and fuel bills. They can also help landlords increase occupancy rates by attracting the growing number of climate-conscious tenants in their market. On top of this, building decarbonization is a key issue for property owners in states with laws capping building emissions and restricting fossil fuel use in buildings, like New York and California.
The survey revealed that 85% of respondents are seeing property owners and investors consider environmental and carbon reduction issues – such as energy use, energy efficiency options, solar technology, smart windows, natural lighting, and insulation – when purchasing real property.
For guidance on decarbonization and other climate-related legislation in New York and California, see Climate Change Legislation Tracker (Real Estate) (NY) and Climate Change Legislation Tracker (Real Estate) (CA). For guidance on New York City’s Local Law 97 from the lender’s perspective, see Through the Green Looking-Glass: A Lender’s Guide to New York City’s Local Law 97.
For guidance on incorporating efficiency and green leasing provisions in commercial leases, see Green Leasing and Green Lease Drafting Checklist.
The majority of survey respondents reported increased difficulty in obtaining flood insurance or significant increase in flood insurance premiums. The survey reveals that 54% of respondents have noticed this trend, while 29% have not observed difficulty obtaining flood insurance or significant premium increases (and 16% of the respondents indicated this issue was not applicable to their practice).
This data is not surprising with the increasing number of floods resulting in significant damage to buildings and property. As a result, fewer insurance carriers are providing flood insurance, and when such coverage is available, property owners are experiencing increases in premiums.
For further information on the increase of flood risks and flood insurance, see Climate Change as a Strategic and Compliance Issue Video, Sea Level Rise: A Guide for Public and Private Projects, Flood Insurance, and ISO’s Flood Exclusion Amendments and Hurricane Ian Claims.