The economics behind both residential and commercial buildings “are going to be under tremendous pressure in the next 18 to 24 months,” said John Fish, chief executive of Suffolk Construction, the largest general contractor in New England. “It’s the first time in my career where the cost of construction is greater than the value created through construction.”
That’s prompting a backlog of projects that are permitted but haven’t yet started work, imperiling efforts to address the region’s housing shortage and to build modern office space better suited for the hybrid, post-lockdown world.
Permits to build just 725 units of housing were issued in Greater Boston in September, according to data from the Census Bureau — down 43 percent from the same month a year prior. Since the start of the year, builders have pulled 8,201 permits, a 27 percent decline from the first nine months of 2022 and the lowest rate for that time period since 2012.
In Boston, the decline is even sharper. Production of new units is down 46 percent through the first nine months of the year, according to data from the Mayor’s Office of Housing, compared with last year, which was an unusually busy time period. Still, permits are running 32 percent behind the average pace of that time period for the prior three years.
Both Mayor Michelle Wu and Governor Maura Healey are considering incentives to spur permitted housing projects into development. The Wu administration would aim to target projects in 2024 and 2025 — and has also launched a short-term pilot program offering tax breaks for converting empty offices into housing — while the Healey administration has included some $50 million to fill financing gaps for housing developments into the $4.12 billion housing bond bill it filed with the Legislature last month.
Meantime, developers are hitting pause.
The Mount Vernon Co., a Boston developer with a portfolio of several thousand apartments, is not building multifamily projects right now, founder Bruce Percelay said at a recent Bisnow event. That “defies logic,” given record-high rents and occupancy rates, Percelay said. But even strong demand for apartments is not enough to take the financial risk of launching construction on more right now.
At the same event, Young Park of Boston’s Berkeley Investments said the one multifamily project his firm is building is a 102-unit apartment development in Allston. The deal only made sense because the project had already received permits and was considered a “distressed” asset, Park said — meaning the property was likely available at a discount. Along with high interest rates, construction costs, and difficulty underwriting deals, he said, a wave of new requirements for everything from energy efficiency to affordable housing means “there is no relief of any kind.”
“The yield we’re expecting will not be there,” Park said. “If you are in a business of making a profit in real estate — it’s tough.”
The difficulties are impacting projects large and small. Last month, attorney Kevin P. Crane sought an extension from Cambridge officials on permits for a six-story residential building in Central Square. The 46-unit project at 600 Mass. Ave. was permitted in 2021, but hasn’t started construction due to “the significant increase in construction costs since the project was initially planned,” Crane wrote.
“Compounding the increase in construction costs has been the significant increase in interest rates,” Crane wrote in his request to extend that permit. “The project was approved at a time when COVID was continuing to negatively affect the stability of markets. Those effects linger on.”
It’s not just here. For the first nine months of the year, nonresidential building starts nationwide fell 7 percent compared to a year ago, while residential building starts dropped 17 percent, according to research from Dodge Construction Network.
“It’s really a very difficult environment,” said John Ferrante, chief executive of the Associated General Contractors of Massachusetts. “There is only a small group of investors and developers that are able to operate in that environment.”
In theory, that should lower labor and construction costs, as contractors drop their rates to compete for jobs. But nonbuilding construction starts — on projects such as infrastructure and utility work — are up 25 percent so far this year, according to Dodge data. Many Boston-area contractors are relying on public and institutional work — with colleges and universities or transportation authorities — to keep their pipelines full. Manufacturing, health care, and retail work remains strong, Ferrante said. And while AGC member firms aren’t building many new offices, there is an element of that side of the business keeping firms busy: corporate office interior work.
“Everybody wants to be in the best situation they possibly can to try to get their employees to come back to work,” Ferrante said. “A lot of our member firms have been doing a lot of interior fit-outs for corporate tenants to try to make the offices more enticing.”
But the prospect for any new office towers to get underway right now is dim.
While several blue-chip tenants have flocked to newly built or renovated towers, there’s not enough certainty about the future of office space to overcome difficulties in financing commercial projects, experts say. Unless an office project has an anchor tenant preleased — such as Bain & Co.’s future headquarters at the corner of Arlington and Boylston streets overlooking the Public Garden — it’s unlikely developers will move forward on new office construction for the next several years.
“Any new construction starts are going to require economic rents — rent and concessions — that are vastly different from the current transactions,” Doug Linde, president of prominent office developer and landlord Boston Properties, told analysts last week. New speculative construction — that is, construction started without a tenant preleased — “is nonexistent in the market today,” Linde said, citing “dramatic increases” in construction costs.
Speculative development was relatively rare in Boston until the building boom of the mid-2010s, and many of the large-scale offices that started construction on a speculative basis prior to or during the pandemic — such as the renovation of One Post Office Square and Winthrop Center downtown, or the redevelopment of the former Edward J. Sullivan courthouse and jail in Cambridge — are in their final stages of work, with sizable blocks of space still on the market.
Linde said Boston Properties recently had a tenant sign a 10-year extension of a 313,000-square-foot lease here, four years prior to its lease expiration. (Boston Properties typically does not identify specific companies on its analyst calls, but real estate research reports indicate the tenant is MFS Investment Management, which extended its lease at the Prudential Center this quarter.)
The client was using all its office space, and believed that space was critical to its operations and business strategy, Linde said. When they considered next steps, they “did not believe that any new construction was likely to be built on a speculative basis.”
“This meant they would need to pay replacement cost rents, and sign a lease now . . . to be in new construction in the Back Bay in four years,” Linde said. “And there are no 300,000-square-foot blocks of high-rise space available in premier buildings in the Back Bay today.”
Some contend a slowdown in overall development can be beneficial as the city and its real estate industry looks to stabilize after a tumultuous few years.
But development difficulties can add pressure on regional banks — which have historically relied on development loans for a sizable chunk of their loan portfolios — and that aren’t interested in funding new projects where there’s no guarantee they’ll be paid back. Nationally, there’s reportedly at least $1.5 trillion of commercial real estate debt coming due by the end of 2025.
“That’s a cloud hanging over everybody’s head right now,” Fish said.