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Inflation is not deterring development

Institutional investors are backing development in constrained asset classes despite pricing and labor pressures.

Even before this year brought the highest amount of inflation in four decades, construction costs were hitting high watermarks. The cost of construction in the US rose 17.5 percent between 2020 and 2021, the highest jump in 50 years, according to figures from the US Census Bureau.

An inflationary environment, compounded by war in Ukraine, has led to continued concerns surrounding construction material shortages and prices and labor shortages.

Yet these market difficulties are not deterring managers from increasing their exposure to development in the most popular real estate markets of logistics and residential.

At the start of the month, Boston-based Rockpoint Group formed a separately managed account with Abu Dhabi Investment Authority for a build-to-core industrial strategy. The partners combined to commit $750 million to projects across the US.

This week, Crow Holdings Capital announced it had secured a further $332 million in commitments for a develop-to-hold multifamily strategy. The Dallas-based manager has been on a development fundraising tear in recent times, raising $750 million for an industrial development fund and $400 million to develop ‘attainable housing’ in a joint venture.

This courage to carry on stems from meaningful undersupply in both sectors, widely regarded as the two hottest in the present day, institutional real estate market.

There is a housing deficit in the US estimated to be more than six million homes, according to Realtor.com. Meanwhile, industrial vacancy in the country reached an all-time low rate at the end of Q1 2022 of 3.4 percent, according to broker JLL. Certain prime areas for industrial, namely Northern New Jersey and California’s Inland Empire, are even at less than 3 percent and less than 1 percent vacancy rates respectively.

There is a consensus that demand for these asset types in the country is not a transitory thing. There also remains a widely shared view that inflation could well be.

Weighing today’s headwinds, pricing concerns are less of an issue for managers than labor constraints, PERE is hearing. Crow Holdings Capital’s chief executive officer Bob McClain, for instance, told us how his firm’s budgeting for its logistics developments includes conservative underwriting to account for the possibility of escalating costs, but that was not upending the overall strategy currently.

Staffing is another matter, other senior executives said. This is an area harder to business plan for, in private real estate just as elsewhere. According to the US Bureau of Labor Statistics, the amount of open construction jobs crept toward 400,000 at the end of March. At 396,000, that was 4.9 percent of the total construction job market. For context, the 410,000 and 5.4 percent in October last year, were the highest figures since the USLBS began recording them back in 2000.

Nonetheless, the fundraising anecdotes demonstrate how institutional capital continues to back development despite inflationary pressures. Even where cap rates are for acquisitions of stabilized assets are near or at historical lows, sheer supply-demand equations are keeping these modern-day portfolio stalwarts firmly in the crosshairs, for now. The overriding consensus for them is these risk-adjusted returns are still worth the play today.