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The Federal Reserve raised interest rates on Wednesday, threatening to boost construction projects that are already teetering on the edge of the financial abyss.
The central bank raised its benchmark interest rate by 25 basis points, its first hike since 2023. The move comes as inflation remains stubbornly above the Fed’s 2% target rate.
The cut will reduce the viability of some planned commercial projects, said Michael Guckes, chief economist at ConstructConnect, a commercial construction data provider based in Cincinnati.
“Overall, higher financing costs will weaken the profitability calculations of owners and developers considering new commercial real estate projects,” Guckes told Construction Dive. “Projects that were close to meeting their profitability targets may now fall short, those projects will not go out to bid.”
The impact could also extend to projects already underway, Guckes added. Short-term credit and prime rate-linked revolving loans will increase as the Fed increases. This will increase borrowing costs for contractors and project owners.
“If the change in rates seriously affects the project owner, that could cause an unexpected delay in contractor payments,” Guckes said. “At worst, the higher rates could force the owner to suspend the project, or even abandon it, leaving the contractor burdened with immediate expenses and accounts receivable that are difficult to recover from the owner.”
But economists are divided on whether Wednesday’s hike will worsen overall construction lending conditions.
Longer-term Treasury yields influence commercial real estate financing more than the Fed’s overnight rate, said Brian Strawberry, chief economist at FMI, a construction consulting firm based in Raleigh, North Carolina. If the Fed’s move reassures bond investors that inflation will be under control, long-term rates could fall, he said.
“A hike would immediately increase the cost of variable rate construction loans, which are real money on projects with debt, but the biggest effect is likely to be lower long-term rates,” Strawberry told Construction Dive. “A hike that convinces markets the Fed is serious about inflation tends to pull the 10-year [Treasury] down, and that’s where the construction really lends itself.”
Inflation affects construction costs
But taming inflation fears is easier said than done, even with Wednesday’s rate hike.
High material and labor costs are already threatening the viability of the project, said Kenneth Roberts, partner and chairman of the construction law group at Venable, a Washington, D.C.-based law firm. Non-residential construction input prices rose 8.9% year over year in August, with several major building materials posting double-digit increases.
In other words, while Wednesday’s hike may help lower long-term borrowing rates, rising construction costs could still prevent planned projects from starting.
“I don’t see any data to suggest that in the next six months, the inflation that the construction industry has experienced over the last year will slow down,” Roberts told Construction Dive. “In fact, I think everyone says the opposite. That is, they think we’re entering an even more inflationary time period.”
Strawberry sees a similar trend in producer price data. Escalating prices for building materials currently far outpace contractor bid prices over the past year.
“This squeeze plus expensive construction debt is thinning the portfolio of new starts,” Strawberry said. “Fewer deliveries eventually mean tighter vacancies and the next round of rental growth and construction. Until then, the planning reality is a capital cost well above the 2010s.”
Sectors with more protection
The rate increase will affect construction unevenly, Strawberry said.
Housing and private commercial development are the most sensitive to borrowing costs, he said. On the other hand, data centers and semiconductor plants, the key sectors of non-residential construction, are much better insulated.
Most of these projects rely on the deep pockets of tech giants or government incentives, limiting the role of borrowing costs.
“A lot of that spending is based on corporate cash flow and high stock values, so borrowing costs barely touch that,” Strawberry said. “This combination is what keeps total spending from falling as much as housing.”
Fed hikes come in ‘waves’
Guckes questioned whether Wednesday’s increase represents a one-time adjustment or is just the preliminary volley of another round of tightening.
Historically, the Fed’s rate changes have come in a series of moves, Guckes told Construction Dive. If this pattern holds, homeowners could face additional increases in borrowing costs after Wednesday.
“It’s important for business owners to realize that in the modern era, Fed rate moves have come in waves,” Guckes said. “In recent decades, the Fed has not raised the federal funds rate once by 25 basis points or 50 basis points and then stayed at that rate for a sustained period of time. Rather, the Fed has a history of making multiple small rate increases relatively quickly.”
