Construction Costs & Interest Rates: The Perfect Storm Hitting Apartment Development

A wave of new apartment complexes is washing over the market in 2024 - the last surge from projects started during the optimistic days of 2022 and 2023. But looking ahead to 2025 and 2026, the pipeline runs surprisingly dry. What changed? Two critical factors have fundamentally altered the development landscape: skyrocketing construction costs and soaring interest rates.

The U.S. apartment development sector hit the brakes hard in late 2023, marking a sharp turn from the record-setting pace of previous years. As interest rates climbed and lending conditions tightened, many developers found themselves unable to make the numbers work. Projects across the country faced delays or cancellations, raising concerns about future housing supply, particularly in high-growth markets.

A Historic Rise in Construction Costs

The construction industry has weathered unprecedented cost increases since 2022. Labor shortages pushed wages up 6-7% annually across all trades, while material costs told an even more dramatic story. Lumber prices swung wildly but remained stubbornly above pre-pandemic levels. Steel, concrete, and electrical components saw price hikes of 20-30% or more. Even basic materials like drywall and insulation posted double-digit increases year after year. Combined with persistent supply chain issues and elevated transportation costs, total construction expenses surged 25-35% from 2022 to 2024.

Interest Rates Jumped As Well

The lending landscape today bears little resemblance to early 2022's easy-money environment. The Federal Reserve's aggressive stance against inflation pushed the 10-year Treasury yield from 1.5% to over 4%, dramatically impacting both construction and permanent financing. Fannie Mae and Freddie Mac borrowing costs jumped from the low-3% range to often exceeding 6%. Bank loans - those used for construction projects - had the largest increases. Rates increased from 3% into the 7%- 8% range. Lenders also tightened standards across the board, demanding more equity, stricter debt coverage ratios, and frequently requiring full recourse.

Rent Growth Alone Can’t Solve This

To get back to the pace of development we experienced over the last 5 years; rents would need to leap 20-25% above current levels. This stark reality reflects both the rise in construction costs and the doubled debt service payments. A project that penciled out at $2,000 monthly rents in 2022 now needs $2,400-$2,600 to deliver similar returns.

How I Think This Plays Out

My guess is that a combination of factors will eventually increase development levels. With apartment development slowing dramatically through 2025 and 2026, natural pressure on rents seems inevitable. While labor costs are historically unlikely to go down, the lack of development could lead to some relief in supply costs. As inflation shows signs of cooling, the Federal Reserve may eventually pivot to lower rates, breathing new life into real estate development and the economy in general. Until then, the multifamily developers face a period of adjustment and patience.

-Ben Michel

Ben Michel is the founder of Ridgeview Property Group, an investment firm specializing in multifamily real estate. Register Here to be notified of available investment opportunities.