Quattro Development Co-Founders Discuss the Future of Commercial Development in the US

In light of economic challenges and changes in consumer behavior, the U.S. real estate market is set for some significant corrections. In fact, according to a report by PwC, increasing interest rates, declining gross domestic product, and decreasing deal flows have led to a “current slump” in real estate.

The temporary downturn has real estate professionals focusing on the long-term game, although experts like Quattro Development’s Rob Walters and Michael Liyeos believe real estate has forever changed. “Commercial development is at a crossroads,” Liyeos explains.

The co-founders are no strangers to the challenges of real estate in a contracting market. In fact, the duo co-founded Quattro Development during the peak of the Great Recession and walked away stronger for it.

Liyeos and Walters have decades of experience in commercial real estate development, but the wake of the pandemic has caused astronomical changes that will shape the industry’s future. The pair share their predictions for the future of commercial real estate in America.

Increasing Construction Costs Bring Expensive Challenges

According to a report by CBRE, construction costs in 2023 will remain higher than the historical average — although they will likely be lower than 2022’s average. In spite of two years of double-digit percentage increases in construction costs, experts predict they will still rise by 5.4% in 2023.

After several years of increases, Michael Liyeos believes it’s only getting more challenging for companies to build the right spaces. “Most tenants want their space delivered exactly to their specific needs, making it difficult to reuse or retrofit existing buildings. In addition to that challenge, construction pricing has hit a high mark, making retrofits nearly as expensive and difficult as building new from the ground up,” he explains.

Retrofitting is no longer as affordable as it once was, so going forward, it’s likely that more chain brands will choose to build from scratch so they can create a property that meets all of their requirements.

Construction Is More Complex and Time-Consuming

Higher interest rates and their impact on financing are one big contributing factor to the shifting tides of commercial real estate, but time and complexity are substantial factors as well. “One of the variables affecting final decisions determining whether to retrofit or start over is timing,” Liyeos says. “Municipalities and governing bodies that approve plans and issue permits have become a bottleneck for development as cities are often understaffed and zoning codes have gotten more complicated, but particularly for ground-up construction, which is subject to more scrutiny and approvals.”

So, even if commercial retailers opt to build from the ground up in an effort to save money, increasingly complex construction processes still make it a challenge to build these new spaces. Going forward, retailers may set their sights on states and municipalities with less red tape to speed up the construction process.

Property Supply Will Likely Stagnate

Quattro Development’s Rob Walters also predicts that the tough economic conditions will lead to a stagnating supply. “With interest rates at elevated levels and banks cutting back on construction lending, the coming 12 to 24 months is going to see a lull in supply for many property types,” he says.

But with a burgeoning population, the demand for housing is still growing in the United States. “For the industry types where there is still excess demand, such as multifamily and industrial and to an extent even retail, I think you will see rent increases because there isn’t enough supply. In my mind, the Federal Reserve may likely be driving up future housing costs with their rapid rate increases because rather than reducing demand, they may be inadvertently limiting supply,” Walters adds.

Walters’ predictions match up with the market. In 2023, experts predict home sales to fall by 6.8% year over year, with an estimated 0.3% increase in home prices. But developers and landlords aren’t just increasing these costs mindlessly — they’re facing an impossible choice.

“The crazy thing is that it isn’t like people are doing pro formas for multifamily to double-digit rates of return in order to have positive leverage. That’s partially because if you did want a 10% return on cost on a project, the rents would have to be so astronomical even if your land cost was minimal due to the rapid increase in construction costs over the past two years,” Walters says.

Developers Will Need to Embrace Creative Lending Options

The Commercial Real Estate Development Association expects nonresidential construction spending to fall to a 5.8% growth rate in 2023 and a 1% growth rate in 2024. Increasing materials costs and interest rates are making loans more expensive for developers, leading many firms to seek alternative financing options.

Quattro Development got its start during the Great Recession, so its co-founders understand the challenges of raising capital in a contracting economy. “I think we thought that … getting our first three projects financed was a very easy checkbox. We needed a lender, and truly they were just dropping like flies in terms of options,” Rob Walters says. Quattro managed to source capital by networking heavily to find a lender, but it wasn’t as easy as they hoped — and they predict this will be the case in the future.

Going forward, Rob Walters and Michael Liyeos believe creative lending is a must. “Quattro has found unique lenders in the current market that have filled the holes left by many banks, either because the banks were pulling back or debt service ratios severely limit leverage with the elevated rents,” Walters explains.

Balancing Opportunities and Challenges in the Future of Real Estate

The future of real estate is bright, but like any market, it will ebb and flow with the economy. The key, according to Rob Walters and Michael Liyeos, is to learn to ride the wave and make the most of current circumstances. “Developers and tenants that can figure out how to best navigate these issues will outperform those who cannot,” Liyeos says.