What Will Fed Rate Cuts Mean for Builders?

Article originally posted on Multifamily Executive on August 30, 2024

All signals indicate the Federal Reserve Open Market Committee will cut rates at its September meeting after eight consecutive rate pauses. With the unemployment rate rising to 4.3% in July and inflation levels measuring less than a percentage point above the Fed’s long-term target of 2%, economic conditions and Fed messaging suggest rate cuts will begin in September, with an additional cut likely in December.

“The bond market is virtually pricing a 100% chance of [a September rate cut], so investors believe it is coming. We think it is likely we will see another rate cut in December, and both of those are expected to be 25-basis-point (bp) [cuts],” says NAHB chief economist Rob Dietz. “We are seeing an economy that is cooling and slowing, but otherwise showing solid signs despite elevated rates.”

For builders and multifamily developers, Dietz says the Fed rate cuts will have an impact on business lending conditions through Acquisition, Development & Construction (AD&C) loans and indirect impacts on long-term interest rates.

Lending Conditions

With nearly two-thirds of homes built by private, regional builders who rely on financing from community and regional banks, more favorable lending conditions through lower AD&C loans will be a positive sign moving forward, Dietz says. More positive lending conditions could have an immediate short-term impact on housing supply.

“AD&C loans are mostly set according to where the prime rate [is]. While it is not exactly one for one, if we were to see 50-bp cuts from the Fed on the fed funds rate over the next quarter or so, you would see the effective annualized interest rates for AD&C loans to go down by 50 bps,” Dietz says.

While lower rates on loans for financing will be “broadly positive” for any business undergoing borrowing, Dietz says in the short run the downward pressure on borrowing rates will be a significant positive for the smaller, private builders who may have lost market share in recent years.

“For smaller, private builders in markets that are undergoing expansion, there is an opportunity to play some catch-up,” Dietz says. “For the land development sector, the availability of financing to acquire and develop land and lots is going to be broadly positive for the industry [for] builders big and small.”

Dietz says the impact will not be as immediate for multifamily developers, but lower lending rates should help create stabilization for apartment starts in the future.

“There are some other factors that have slowed apartment construction, including roughly 1 million apartments in the construction pipeline—which is the highest number since 1973,” Dietz says. “But if we are thinking about a two- to three-year window, as some of that excess inventory works through the system, as household formations continue, then when multifamily builders are ready to begin stabilizing and reaccelerating the pace of apartment construction, lower financing cost will be an important part of the recipe.”

Mortgage Rates

While not directly controlled by the fed funds rate, long-term mortgage rates will be indirectly influenced by rate cuts. Dietz says rate cuts, coupled with inflation remaining in line with expectations, will put downward pressure on long-term interest rates.

“We think the Fed is likely to be entering a period of fairly predictable 25-bp cuts over the next few quarters. We are looking at two under our current forecast for the rest of the year, and next year we could see four to six depending on the data,” Dietz says. “The impact on long-term interest rates is that the 30-year fixed-rate mortgage by the end of 2025 could fall below 6% on a sustained basis. That would be good for demand.”

Presidential Election

With a September rate cut a near guarantee, many economists suggest the result of the November presidential election will not impact the Fed’s activity during its December meeting.

“It appears, at least the bond market seems convinced, that the Fed is not looking at the political calendar right now,” Dietz says. “The macro data right now that inflation is moderating, getting closer to the 2% [long-run target], that’s a green light for the Fed to cut.”

Dietz says the decline of total job openings to near 8 million is also a strong green light for the Fed to cut independent of the election results.

Shift to Focus on Fiscal Policy

As the Fed begins entering a period of monetary easing, Dietz says builders should begin to focus more on fiscal policy as it relates to interest rates. He says moving forward rates will be more dependent on the future of fiscal policy, including taxes and government spending.

“Whether it is new spending programs or tax policies, anything that can increase the federal debt represents an interest rate risk for the residential construction industry,” Dietz says. “We will be going from watching the Fed and hoping the Fed cuts rates to benefit the industry to looking at the size of debt and its impact on mortgage interest rates.”

Dietz says as federal debt levels increase, it will put upward pressure on long-term interest rates. He shares that steadily increasing federal debt, caused by additional spending and expansions for programs such as Social Security and Medicare, is likely to increase long-term nominal interest rates, including mortgage interest rates.

“For those builders that are engaged and interested in policy, there is going to be this pivot as we move into 2025 thinking less about interest rates being determined by the Fed and more determined by fiscal policy [instead],” he says.