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Construction executives welcomed the Federal Reserve’s 0.5 percentage point rate cut announced on Wednesday, saying the move is the start of broader easing that is likely to spur new project starts .
“If we have a series of rate cuts over the next three to six months, that’s likely to start showing up in lower construction. [loan] rates and greater availability of equity investment towards the end of this year and into next year,” said John Sullivan, chairman of the US real estate practice at DLA Piper, a London-based law firm “As rates come down, borrowing costs will also come down for many projects and there will be more real estate investment and construction activity.”
The Fed The move follows 11 rate hikes in early 2022 to combat rising inflation. Despite a generally positive reaction to the cut, construction executives said the full impact of the lower rates will take time to materialize as financing timelines and project planning processes adjust to new environment
In other words, while lower rates are encouraging for construction activity, it’s only part of the equation, said Cory Moore, CEO of Big-D Cos., a general contractor based in Salt Lake City.
“The cut in interest rates is generally good news for the construction industry as it lowers borrowing costs and may encourage more investment in new projects,” Moore said. “That said, to really move the needle, loan-to-value ratios will need to improve along with the rate cut to make financing even more attractive.”
Impact on project lines
Construction executives agree that construction activity tends to be a lagging indicator of the economy. So while the rate cut is welcome relief, executives caution that the industry’s long project cycles mean any pick-up in activity will be gradual.
“With rates declining, we expect demand for new projects to begin to gradually increase through 2025,” said Anthony Johnson, president of the industrial business unit at Clayco, a Chicago-based construction company. “However, it will take time for these projects to go through planning and design and start construction in the field.”
Will Pender, president of the Gulf States region at Adolfson & Peterson, a Minneapolis-based contractor, echoed that sentiment. He pointed out many projects were shelved during interest rate hikes due to high capital costs, but a sustained decline in rates could bring developers to the table.
“I don’t think the impact will be felt immediately, but it’s a good first step,” Pender said. “I see construction starting to pick up in the first quarter and the second quarter of next year.”
Owners and developers added more projects to the planning queue in August, anticipating stronger market conditions next year, according to the Dodge Construction Network. The Dodge Momentum index, a benchmark that measures nonresidential construction planning, rose 2.9% in August, with growth in most nonresidential sectors.
Impact limited by labor and material costs
The broader economic environment, including labor shortages and material costsit will also affect how quickly the rate cut translates into increased construction activity. For example, Johnson highlighted continued strength in sectors such as data centers and manufacturing, which have remained largely resilient despite the higher rates.
The rhythm of breaks in these sectors has already put a huge strain on resources across the industry, Johnson said. Therefore, as more projects in different sectors came up in the queue, competition for labor and materials it will only intensify.
“Increase in demand in the coming years in multi-family and light industry [sectors] it’s only going to increase the already stretched labor demand,” Johnson said. “So it’s going to be important to watch the quality of labor as well as the cost of labor.”
However, many leading real estate investors think the values of some asset classes are at or near the bottom, Sullivan said. That means lower interest rates will be another added tailwind to increase investment and construction activity, although it may not lead to an immediate boom.
“Lower interest rates are not a panacea, but they make many projects more affordable and can generate positive sentiment in the market,” Sullivan said. “It often takes time for a cut in the federal funds rate to translate into a cut in construction loan rates, but positive sentiment can drive investment sooner.”
