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The 2021 Outlook for Construction Lending

Posted by Barry Watson on Dec 14, 2020 9:00:00 AM

Like many sectors, the construction industry has experienced a COVID-19 roller-coaster ride this year. After a strong start to the year, the Dallas/Fort Worth construction market saw a 7.5% year-over-year decline by the end of the third quarter.

While construction was deemed essential work in many regions of the country, overall construction activity across the country has slowed. Funding remains available, but many contractors wonder what 2021 will bring. The construction industry's conundrum is that lenders still want to finance good projects, but some developers are hesitant to begin new construction during this uncertain time.

Adapting to the New Normal in 2020

Dodge Data & Analytics reported that total U.S. construction starts in 2020 were down 15% year-to-date through July and nonresidential construction dropped 25%. Although much of the industry began in 2020 with a healthy backlog, the slowdown in new projects reduced a backlog and created a more competitive bidding situation for the reduced number of projects moving ahead.

A Changing Landscape for Financing

Property owners and developers have reacted to the COVID-19-induced economic uncertainty by delaying closings on land deals and construction starts. Lenders initially pulled back on financing, but the flow of money has eased more recently. However, lenders are tightening their loan criteria, and they favor new construction and renovation construction loans as they seek to put good loans on the books should economic conditions worsen.

The delinquency rate for commercial mortgage-backed security (CMBS) loans reached a high of slightly more than 10% in June, which was near the all-time high in 2012 for the delinquency rate on CMBS loans. The delinquency rate differs among asset classes, with hotels and retail properties hitting higher levels than other asset classes. Office properties, warehouses, and multifamily properties remain relatively strong with fewer delinquencies.

Many commercial property owners have had tenants unable to pay rent during business shutdowns. As a result, they were not able to service their debt and sought loan modifications. This trend will likely continue into 2021 as the economy struggles to recover.

The pandemic has shattered state and municipal budgets. For this reason, many infrastructure projects have been put on hold as funding was reallocated for pandemic assistance. One exception has been K-12 school construction projects funded through municipal bond programs, which are being approved by record numbers across the country.

Many construction companies and contractors that received Paycheck Protection Program (PPP) loans have been able to stay solvent and retain their employees. However, economic growth has stalled since June, and Congress has not approved an additional stimulus plan. Bankruptcies are on the rise and those contractors with high overhead costs may need to find new ways to increase liquidity and reduce costs to stay in business. A construction accountant can help contractors review their costs in light of these changes as well as provide PPP loan forgiveness consulting.

Outlook for 2021

Overall nonresidential construction spending in 2021 will be down 4.8% according to the Consensus Construction Forecast, a summary of industry projections compiled by the American Institute of Architects (AIA). Volatility in the construction market will likely continue until the pandemic is under control. Again, lenders will continue to tighten their loan criteria, and many are putting stopgaps in place to protect their interests if something negative occurs in the future.

Hospitality, retail, and restaurant construction projects will remain on hold indefinitely. Construction financing will be easier to obtain for asset classes that show the most promise for construction starts in 2021. These include:

  • Office construction projects, which focus more on renovation and adaptation to provide safe work environments for workers. Some offices will be adapted for safe “hoteling” settings for workers who will split their time between the office and home in the future.
  • Warehouses, distribution centers, and grocery stores remain strong as more consumers have shifted to online purchasing with home delivery or curbside pickup.
  • Medical research, life sciences, and healthcare facilities continue to indicate robust growth as the pandemic continues. Many healthcare facilities have had to renovate their facilities to accommodate new ways to see and treat patients.
  • Many contractors who typically work on hospitality projects may shift over to housing construction during 2021. The residential housing market is strengthening, both in the number of mortgage applications for existing homes and new residential building permits. Housing is considered a leading indicator for both the overall economy and for the broader construction sector.

According to the Cumming Construction Management market report, the Dallas/Fort Worth construction market overall is expected to decline 10% in 2021. Commercial construction is projected to decline 11.4%, and residential construction will fall 15.6% in 2021. However, activity is expected to pick up by mid-to-late 2021, with manufacturing construction projects leading the way. The Dallas/Fort Worth construction market is predicted to rebound by 2022.

Do you have questions about construction lending or other construction industry topics? Our construction accountants and advisors can help. Contact Barry Watson, CPA, at 972-818-5300.

Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.

Topics: Construction, Financing, Lending