Rising Cost of Money’s Impact on Construction: How the Sector is Managing Interest-Rate Pressures
By PHILLIP ROSS, CPA, CGMA, PARTNER
In late July 2023, the Federal Reserve raised interest rates again by a quarter of a percentage point to 5.5%, reaching its highest level in 22 years. In a fight to counter persistent inflation, borrowing rates have become significantly more expensive since the program began in March of 2022, which has had no small impact on the cost of financing in construction lending. The stated intention was to decrease the overall demand for goods, services and labor in the economy to fight rising prices.
However, increased borrowing costs have adversely affected numerous industries, including construction, that enjoyed an unusual decade of lower interest rates. As costs have increased, the American Institute of Architects estimated earlier this year that nonresidential construction spending is expected to slow to a growth rate of 5.8% in 2023 (down from 10% in 2022) and then fall to a mere 1% growth rate in 2024.
Economic experts, in some cases, insist inflation is still running too high even though recession seems less imminent now. Core inflation, for example, excluding the price of gas, food, and shelter, has remained at a 4% annual increase since the beginning of 2021. We are witnessing a new floor in pricing and it remains to be seen what the longer-term impact will be in construction as increased materials costs are palpable industry-wide.
A Major Question Now is Where Do We Go from Here?
There is light at the end of the tunnel. According to S&P Global, nonresidential and residential construction loans at U.S. banks rose alongside delinquencies in the first quarter of 2023 from the previous quarter. Despite increased borrowing costs, construction loans also grew as a percentage of gross loans and leases, reaching 3.93% in the first quarter, marking the highest percentage in at least eight years.
We also see optimism for construction activity in terms of the demand for labor. A leading trade association of employers predicts that the construction industry will need to attract more than 500,000 extra workers in 2023 in addition to the normal pace of hiring.
While tighter lending standards stemming from problems at regional banks have made it even more challenging for construction firms to secure or extend lines-of-credit-loans, banks are lending to those construction firms they know and where a relationship and history have been established.
New York is looking toward new horizons that will benefit construction firms. New York City Mayor Eric Adams announced plans to rezone manufacturing areas south of Times Square and allow more office buildings to be converted to housing with hopes that new housing development will help ease the shortage of housing supply in the city. The plan aims to create 20,000 new homes to accommodate 40,000 New Yorkers over the next 10 years. The rezoning will center on midtown south covering 42 blocks between 23rd and 40th streets and Fifth and Eighth avenues. Ultimately, the plan is to create a more diverse geographic space with increased housing that includes affordable apartments as well as retaining office space.
The New York City Department of Design and Construction has also prepared to continue with its original blueprint to increase the capital project plan laid out several years ago in 2019. The plan aims to expedite how the city budgets, procures, and permits capital projects to reduce onerous and lengthy wait times to complete delivery plans.
Infrastructure spending is also hopeful—one example is the long-awaited Gateway Tunnel project that will build a second rail tunnel beneath the Hudson River between New Jersey and New York City. To date, the project is set to receive $6.9 billion. Other significant infrastructure proposals and projects, such as the recently announced $631-million flood wall in lower Manhattan and additional spending, all point to New York being replete with critical infrastructure needs that will always bode well for a strong construction industry.
New York is always building—with multiple new infrastructure and other projects on the horizon, construction firms are finding ways to overcome unprecedented economic times. Once again, the city that never stops building will continue to rise and meet the new challenges that lie ahead.
About the author: Phillip Ross, CPA, CGMA is an Accounting and Audit Partner and Chair of the Construction Industry Group at Anchin, Block & Anchin, LLP. For more construction industry thought leadership and content, log on to www.anchin.com.