The Los Angeles Development Gridlock: Breaking Down the Barriers to Progress

Hi Everybody,

Apologies for being quiet the last few months. We've been busy!

I hope this message finds you well as we approach the end of 2024. It's been some time since our last communication, and I wanted to take a moment to reconnect.

As we approach the end of 2024, the Los Angeles development landscape remains entangled in a web of challenges that have rendered many projects financially unfeasible. This analysis delves into the core issues preventing development projects from moving forward and outlines the critical changes needed to revitalize the sector.

1. The Interest Rate Squeeze

Current Situation

- Federal funds rate: 4.75% - 5.00%

- 30-year fixed mortgage rate: averaging 6.5%

- Construction loan rates: 7% - 12%, depending on lender source

Why Development Doesn't Make Sense

1. Feasibility Evaporation: Projects that were viable at 3-4% interest rates are now underwater.

- Example: A development project in LA that projected a 15%+ IRR in 2021 now barely breaks even.

2. Capital Drought: Lenders now require 40-50% equity for new construction projects, up from 20-30% pre-rate hike era.

- Consequence: A developer who could previously juggle three projects simultaneously is now limited to one, significantly reducing overall housing production.

3. Refinancing Paralysis: Developers with floating-rate loans or approaching refinancing face significant challenges.

What Must Change

1. Federal Reserve Action: A clear, committed path to rate stabilization and reduction is crucial. The development community needs certainty to plan long-term projects.

2. Innovative Financing: The industry must embrace alternative structures:

- Mezzanine debt with equity kickers to align lender-borrower interests

- Preferred equity structures with clear exit strategies

- Public-private partnerships leveraging government credit to reduce borrowing costs

2. The Regulatory Labyrinth

Current Situation

- Entitlement process for multi-family projects: 1-2 years

- Fees reaching $20,000+ per unit

- Constantly shifting regulations creating a moving compliance target

Why Development Doesn't Make Sense

1. Timeline Uncertainty: Extended approval processes make accurate cost and market projections impossible.

- Financial impact: Each month of delay erodes 1-2% of a project's potential ROI.

2. Fee Burden: High fees are killing projects before they break ground.

3. Regulatory Roulette: Constant changes in regulations create an unstable planning environment.

What Must Change

1. Approval Fast-Track: Implement a "shot clock" for approvals. Projects meeting pre-set criteria should be automatically approved if not explicitly rejected within a set timeframe.

2. Fee Rationalization: Conduct a comprehensive study of fees. If fees are cut in half, more projects will get built, potentially increasing overall revenue for the city while spurring development.

3. The Construction Cost Conundrum

Current Situation

- Construction costs in LA increased by 30%+ in the last 5 years

- 35% of contractors report difficulty filling positions

- Material cost fluctuations of over 30% for key materials within a single quarter

Why Development Doesn't Make Sense

1. Budget Chaos: Volatile costs make accurate budgeting nearly impossible.

2. Labor Logjam: Skilled worker shortages are causing delays and driving up costs.

3. Supply Chain Surprises: Ongoing disruptions cause material shortages and price spikes.

What Must Change

1. Material Innovation:

- Incentivize the use of alternative, cost-effective materials that don't compromise on quality or safety.

2. Labor Cost Management:

- Streamline work schedules and improve on-site efficiency.

- Remove prevailing wage requirements for certain project

3. Regulatory Streamlining:

- Reduce excessive building code requirements that add substantial costs without significantly improving safety.

- Allow for more design flexibility to avoid expensive customizations.

4. Local Supply Chain Development:

- Incentivize local manufacturing of key building materials to reduce transportation costs and supply chain vulnerabilities.

Conclusion: Charting the Path to Viable Development

For LA development projects to make sense again, we need a coordinated, multi-faceted approach:

1. Interest Rate Relief: The Fed must provide a clear path to lower rates, while developers innovate with alternative financing structures.

2. Regulatory Overhaul: Streamlined processes, reduced fees, and policy stability are essential to cut costs and reduce uncertainty.

3. Construction Innovation: Embrace cost-effective materials and methods to combat volatility and labor shortages.

4. Market Alignment: Policies must adapt to current demands, especially in addressing the "missing middle" in housing.

The challenges are formidable, but not insurmountable. With concerted effort from all stakeholders, we can create an environment where development projects not only pencil out financially but also contribute to a more vibrant, equitable, and sustainable Los Angeles.