How the Rising Fed Rate Affects Your Construction Business
The rising Fed rate has many people wondering whether to buy, sell, or just crawl under a rock and wait for clearer skies. Whether you’re in the business of new construction or remodeling, understanding how the Fed rate affect your business is key to proper planning and selling.
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.
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 increased may help you fill jobs. As it slows the economy, there is less hiring 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, you’ll start paying more in interest as rates rise.
Do You Really Need a New Truck?
Like credit cards, auto loans are tied 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 is rising, lock that loan in soon or wait and pay cash when you can afford it.
Remodelers Will Feel it More
If your client base is full of people using a home equity loan to cover their remodeling or renovation costs, you’re likely to feel the Fed rate increase 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’ve been rising steadily in 2018, though.
Mortgage-backed securities – where your mortgage and thousands of others get wrapped up together in an investment vehicle – are what drives mortgage rates much more directly. If they are less attractive to buyers, rates need to increase to offer a better return for the investors.
Nothing stalls home sales like fear. If you’re targetting higher-value homes, you’re likely including features that other builders use as upgrades. Pull back on that some to offer a lower starting price. Your buyers will feel like their getting a good value and are more likely to buy upgrades with that mindset.
One of the major unknowns for the housing industry right now is how the combination of a rising Fed rate and tariffs will interact. For those construction materials that you won’t purchase right after everyone signs the contract, don’t be afraid to include an escalation clause. This will help protect your bottom line with the contracts you’re putting in place so it doesn’t add to the pinch of a potentially slower market.
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 its 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.