How the Rising Fed Rate Affects Your Construction Business
Whether you’re in the business of new construction or remodeling, understanding how the rising Fed rate affects your business helps with proper planning and selling. A rising Fed rate causes many people to wonder whether to buy, sell, or just crawl under a rock and wait for clearer skies.
If you’re unfamiliar with the term, the Fed rate is the percentage rate that banks lend reserve money to each other overnight to maintain minimum reserve requirements. Why we pay attention to it in the housing industry is that a rising Fed rate has a ripple effect.
Quick Article Summary
- The Fed rate slows inflation
- Hiring may get easier
- Fed rate affects credit card rates
- Auto loans also tied to the prime rate
- Mortgage-backed securities drive mortgage rates
- Consider adding escalation clauses
Things to Remember During a Rising Fed Rate Cycle
The Fed Rate Helps Slow Inflation
In a strong economy where people are making money hand over fist, a rising Fed rate slows things down. It’s not that they don’t want you making money, it’s that they don’t want consumer prices to shoot up so quickly that they get out of control. After all, who wants to pay $100 for a loaf of bread?
Hiring May Get Easier
If your construction business is in good financial shape, those Fed rate increases may help you fill jobs. As it slows the economy, hiring slows and potential employees don’t have nearly as many options. Instead of paying $30 an hour for a new guy with no experience, he’s more likely to take the job at $15 an hour where you value it.
Watch Those Credit Cards
The Fed rate affects short-term debt most of all, and credit card rates are tied directly to it. If you operate your business from a credit card and don’t pay it off every month, your interest payments follow the rising rates.
Do You Really Need a New Truck?
Like credit cards, auto loans relate to the prime rate, which is tied to the Fed rate. You’ll have to pay back a lower interest rate on loans when the Fed rate is low. If the rate rises, lock that loan in soon or wait and pay cash when you can afford it.
Remodelers Will Feel it More
If your client base includes a large number of people using a home equity loan to cover their remodeling or renovation costs, any Fed rate increases affect you even more. HELOC (home equity line of credit) is in the same boat as credit cards and auto loans, tied to the prime rate. As the Fed rate goes up or down, so does that HELOC rate.
Relatively speaking, money is still cheap on a historical level. Talk about the “opportunity cost” of waiting with your clients and see if you can get ahead of the curve.
Educate Your New Construction Clients
There’s a common fear that the Fed rate drives mortgage rates, but the truth is that there’s very little direct effect. Mortgage rates stayed pretty stable in 2017 despite three Fed rate hikes. They rose steadily in 2018, though.
Mortgage-backed securities—where your mortgage and thousands of others get wrapped up together in an investment vehicle—drive mortgage rates much more directly. If buyers find these less attractive, rates need to increase to offer a better return for the investors.
Nothing stalls home sales like fear. If you target higher-value homes, you may include features that other builders consider upgrades. Pull back on that some to offer a lower starting price. Your buyers will feel like they’re getting a good value and have the mindset to buy upgrades.
One of the major unknowns for the housing industry center on how rising Fed rates interact with tariffs. For construction materials not purchased right after everyone signs the contract, consider including an escalation clause.
Editors Note: Escalation clauses help protect your bottom line. They ensure a slowing market doesn’t negatively affect the contracts you put in place prior to a downturn or rise in material costs. If costs go up, they kick in to allow you to adjust the contract accordingly.
One big thing to note here: Don’t act embarrassed or feel like you need to beat around the bush with escalation clauses. Explain to your client why it’s there and be upfront about it. Be prepared to at least discuss alternative materials that are being produced in the US and won’t go up in price due to tariffs.