Factors Driving Real Estate Constructiona) Expected demand, property sales prices, and rents When the market vacancy rate is low and new construction activity is restrained, strong demand increases will result in greater property rent and value gains. For this reason, it is very important to understand how the aforementioned factors contribute to the reduction of development and new construction activity in a real estate market. The following changes in these factors are likely to result in reduced levels of new construction (assuming all other factors that affect new construction remain constant): a) Worsening of expectations regarding future demand, rents, and property rents/prices will result in less optimistic revenue projections and lower profitability estimates, which will induce developers and investors to supply a lower amount of new space in the market. b) Land and development cost increases will increase project costs and, for a given level of expected property revenues, will reduce profitability, thereby discouraging some developers and investors from proceeding with planned projects. Therefore, new construction activity should decrease as a result of such developments. Rosen and Smith (1986) detected a strong statistical relationship between increases in construction costs and decreases in housing additions and alteration expenditures. c) Interest rate hikes will increase the cost of borrowed funds and make several large projects infeasible or too risky to finance with borrowed funds. Therefore, such events should result in a deceleration of real estate construction activity. d) Reduction in the relative profitability of real estate investments relative to alternative investment vehicles will induce large financial institutions to reduce the percentage of their investment portfolios in real estate. This will result in a decrease in the flow of equity/debt capital in real estate development projects, which in turn should contribute to a decline in real estate construction activity.
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