Rising Rates, Construction Costs Force Developers to Get Creative With Financing

Rising construction costs are slowing commercial real estate development in 2026, pushing developers to find creative ways to get projects across the finish line.

In an Associated General Contractors of America survey released in September, 55 percent of respondents reported delaying, cancelling or scaling back at least one non-data center project over the past six months with one-third of companies polled citing increasing construction expenses as the main reason.

Construction input prices rose 1.2 percent month-over-month in August and were nearly 9 percent higher than August 2025, according to an Associated Builders and Contractors report from the statistics produced by the U.S. Bureau of Labor Statistics released Sept. 10.

Despite the data, a number of commercial real estate owners are still seeing development projects through, even if they sometimes have to take on different forms in size and scope.

Ari Rastegar, founder and CEO of Rastegar Property Company, said elevated construction costs have prompted more creativity around trying to achieve development projects’ projected internal rates of return (IRR) such as changing a property’s height or parking requirements.

Rastegar noted his firm changed the density for the residential portion of its planned 318-acre Infinity Square master-planned community in Kyle, Texas, featuring 1,000 single-family homes, 1,400 apartments, 185,000 square feet of commercial space and an elementary school. To account for the new market conditions, Rastegar increased the number of single-family homes in the development’s first phase by 14.8 percent to 388 with the added 50 units to be built smaller in an area initially envisioned for commercial use.

“We reconfigured the plan for market conditions based upon all the issues we can’t change as we can’t change rates and we can’t change construction costs, but the demand is there for these smaller homes,” Rastegar said. “By having smaller houses, the builders then can take lower risk in terms of the total construction costs and hopefully we can overcome the IRR issue by adding density.”

Construction cost challenges were also presented to Rastegar within his 600,000 square-foot INF1NITY Park industrial project in a federally designated opportunity zone in Austin, Texas, near the Tesla Gigafactory. Rastegar, who pre-leased the project and secured a seven-year, $25 million refinance loan from Aegon Asset Management in February 2026, was proactive in getting construction across the finish line by locking in material costs ahead of potential increases.

“It was like pulling freaking teeth as we literally had to pre-order our steel ahead of time and create a hedge in place and an arbitrage to make sure we didn’t get screwed on the steel,” Rastegar said. “We have continued to build and continue to deliver in all different asset classes because we have had to take the creative approach in using different methodologies to create longer-term value.”

Developers, who were already grappling with a higher inflationary environment due in part to supply chain headwinds during the COVD-19 pandemic, received another blow in April 2025 when President Donald Trump announced wide-scale global tariffs. Costs for materials have also soared since Iran closed the Strait of Hormuz after the U.S. and Israel launched joint military strikes on the country in February 2026.

Steven Wernick, a land use and zoning partner at law firm Day Pitney in Coral Gables, Fla., has advised a number of developers in South Florida in trying to adapt construction projects to the new financial realities by changing the designs. He said in some cases developers, both national and local, secured zoning approvals two to three years ago, and are now looking to change height and parking requirements to help increase investment returns.

“The issue is not just about the construction costs, but really trying to maximize the value of the project and how can they better position the project to pencil,” Wernick said. “When a project stops working with today’s costs or the original fundamentals, the first question that often comes to us is whether they can revisit the entitlements and are there any changes in terms of what they’re allowed to build on the site.”

Wernick noted that the higher cost environment for construction and higher-for-longer interest rates has also led to a bigger variety of financing sources for development projects beyond traditional banks. He said that more private lenders and family offices have been linking up with sponsors on the debt and equity side to join the capital stack in construction loans for South Florida developments given the elevated borrowing costs.

Despite drops in overall construction activity and lending over the past year, there has been a recent uptick in inquiries for construction lending, according to Tony Fineman, senior managing director and co-head of national originations at Acore Capital.

“The pullback in construction activity over the past year or two can be attributed to higher costs and more selective equity,” Fineman said. “As a result, the construction deals that do come to market are generally more attractive.”

CRE owners have faced increased barriers to securing construction financing in the last four years. It was back then that the Federal Reserve began hiking interest rates from near zero borrowing levels to combat inflation, and kept going for 16 months until July 2023. After a more than three-year pause in rate hikes, the Federal Reserve raised its benchmark interest rate a quarter point on Sept. 18 to between 3.75 percent and 4 percent, prompting the 10-year Treasury yield to cross the 5 percent threshold.

S3 Capital, which has carved a niche in multifamily construction lending over the last few years, is still seeing strong loan volumes this year, according to Shawn Safdie, head of origination at the New York City-based firm. Safdie, who mainly focuses on lending in the New York region, said multifamily developers he deals with remain committed to building amid the financial headwinds.

“They are not walking away from either new projects or stuff that’s in the pipeline, but they are sizing up loans differently,” Safdie said. “They are adjusting and tweaking their spreadsheets and their financial models, and their costs of capital.”

Safdie said he is working with developers on stress tests for construction loans with adjusting budgets and soft costs. He noted that many of the bigger, seasoned borrowers they work with have experienced various different challenging market cycles, and are more likely to press ahead to make the finances work as opposed to smaller, newer developers, who might opt to delay projects.

While development projects have slowed due to the one-two punch of elevated interest rates coupled with higher construction costs, there has also been an offsetting effect: subcontractors more willing to take lower fees to keep their teams active. That’s according to Nitin Chexal, founder and CEO of Palladius Capital Management.

Chexal, who works on both the lending and investment side of CRE, stressed that while overall construction activity is down, the environment is still far busier than past periods of economic dislocation like the 2008 Global Financial Crisis.

“There’s more selectivity going on, but it’s not a 2008 ‘credit is frozen’ moment,” Chexal said. “The credit space is awash with liquidity right now, so I think a lot of loan requests are getting fulfilled.”

While construction material expenses have risen since the onset of the Iran war, project costs have dropped slightly on an annual basis at Middleburg Communities, a Vienna, Va.-based multifamily developer.

Tommy Gallagher, director of construction operations at Middleburg, said construction costs on the firm’s developments are down 1 to 2 percent overall compared to the same period in 2025. He noted, though, that the numbers can vary far differently in individual higher-priced markets like New York and San Francisco.

Gallagher said decisions on whether to pursue projects today are largely made on a case-by-case basis with other cost factors in play besides construction. These include interest rates, taxes and fees along with challenges receiving necessary permits in some municipalities.

“It comes down to project fundamentals, and your land basis, interest rates and capital markets,” Gallagher said. “The better projects are going to win in this type of environment as they are going to be able to overcome some of the adversity that’s in the market today.”