The Federal Reserve Open Market Committee’s July meeting was the last hope for a summer rate cut. The commercial real estate community had been waiting with suspenseful optimism that the FOMC would move to lower interest rates in July, although economists had mixed forecasts about what might happen. In the end, The Fed opted to keep interest rates unchanged once again, as it has at every other meeting this year. So, no, there will be no rate cut this summer, and now all eyes are on The Fed’s next meeting in mid-September.
The higher rate environment—at least for a few more months—is likely to put more pressure on weary commercial real estate developers, who, after navigating high construction costs from tariffs and a labor shortage, were hoping for some reprieve on borrowing costs. Here is a closer look at The Fed’s decision on interest rates and how the development community is reacting.
Fed Leaves Rates Unchanged
At the July meeting, the Federal Reserve maintained the current target range of 4.25% to 4.5%. The Federal Reserve Chair Jerome Powell pointed to a healthy labor market with continued risks of inflation as the reasoning for keeping interest rates unchanged. “Despite elevated uncertainty, the economy is in a healthy position. The unemployment rate remains low, and the labor market is at or near maximum employment,” he said, adding, however, that “inflation has been running somewhat above our 2% objective.” That dynamic moved the FOMC to hold steady on interest rates. While there are many concerns among economists that The Fed is moving too slowly on rate reductions, Powell said that the current healthy state of monetary policy leaves The Fed “well positioned to respond in a timely way to potential economic developments.”
Not all board members agreed. For the first time in 30 years, The Fed’s decision on monetary policy was not unanimous. Board members Christopher J. Waller and Michelle W. Bowman dissented, voting to lower interest rates. Both board members found inflationary risk to be limited, but instead showed deeper concerns over the labor market. “When labor markets turn, they often turn fast,” said Waller. “If we find ourselves needing to support the economy, waiting may unduly delay moving toward appropriate policy,” Waller said in a statement released after the meeting. In a similar statement, Boman said The Fed should move its focus to the labor market. “With inflation on a sustained trajectory toward 2%, softness in aggregate demand, and signs of fragility in the labor market, I think that we should start putting more weight on risks to our employment mandate,” she said in a statement on her dissent.
Signs of a Weakening Labor Market
The labor market is at the center of The Fed’s debate over interest rates. At the July meeting, most board members were confident in the strength of the labor market and maintained a focus on lowering inflation with elevated interest rates. Then, two days later, the July jobs report showed signs of slowing employment. In July, employers added only 73,000 jobs, pushing unemployment from 4.1% to 4.2%. Then, the labor market revised labor reports from May and June, effectively erasing a 258,000 job gains that it had reported in previous reports. This was the most significant downward revision since May 2020.
Economists have immediately responded. As reported by Yahoo Finance, Sarah House, senior economist at Wells Fargo, said, “The ‘solid’ state of the labor market described by the FOMC earlier this week looks more questionable after the July employment report”; Citi economist Veronica Clark said, “This definitely does look like a labor market that is weakening”; and Heather Long, chief economist at Navy Federal Credit Union, said, “The labor market now looks a lot weaker than expected.”
It will likely take some to understand the true impact of the jobs reports, but a weakening labor market casts increased uncertainty on the state of the economy, and it has outsized implications for the commercial real estate industry, as it directly affects demand-side fundamentals across asset classes. High unemployment will have an outsized impact on development projections for multifamily projects.
High Hopes for a Rate Cut in September
While a weakening labor market is never good news, it does increase the possibility of a rate cut at the September meeting. Although Powell has said repeatedly that he does not know what the FOMC is going to do in September. “We have made no decision about September. We don’t do that in advance,” Powell said in his post-meeting remarks in July. However, the CME Group’s FedWatch tool has a 77.7% prediction of a 25-point rate cut in September. Morning Star Economist Preston Caldwell said, “Unless the next two months’ jobs numbers improve considerably from the figures released today, the Fed is very likely to cut in September.”
While some major financial institutions agree about a rate cut in September—JP Morgan and Barclays, for example—are predicting one 25-point rate cut in September, others are predicting more aggressive cuts this year. Goldman Sachs and Wells Fargo are both forecasting three rate cuts totaling 75 basis points this year. The data is still evolving, and it is still too recent after the latest Fed meeting to make any valid predictions. However, commercial real estate developers are hopeful interest rate relief will come soon.
Commercial Real Estate Development Stays on Pause
Commercial real estate developers have been battling elevated interest rates for the last three years, and it is impacting project pipelines significantly. Both The Real Estate Roundtable’s second quarter report and NAIOP’s commercial real estate sentiment index shows that there is weakening confidence about capital availability for commercial real estate investment and development. The Fed’s decision is likely to exacerbate that trend, and lead to the contraction of new construction starts or an approach to new construction that allows for better opportunity to mitigate capital risk. Robert Brown, CEO of GCM Contracting Solutions, has seen that trend with his developer clients, telling Construction Dive, “We’re seeing heightened scrutiny on financing and pro forma performance. Clients [are] looking to preserve flexibility, whether that means phasing a project, streamlining specifications or delaying vertical construction.”
Design-build construction strategies are one way that developers are trying to reduce costs and increase speed to market, says Brown, and it can be a differentiator. Technology solutions are another opportunity to better manage and reduce costs. Modern real estate development software like Northspyre is providing a lifeline to developers that are overwhelmed by cost increases. Using automation, AI and machine learning, Northpsyre is able to track budgets and spending, contracts, invoices and even make accurate predictions about market trends that can impact costs. It is a game changer for real estate project management, saving substantially on budgets and overages, and reducing administrative responsibilities to give project managers more time to focus on the project. The savings and efficiencies gained can help to offset inflexible costs, like higher interest rates. Today, this is how developers are mapping a path forward.
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