The Federal Reserve announced its first interest rate cut since the pandemic on Wednesday, a move that real estate developers say could eventually help jumpstart construction of new apartment complexes in downtown Chicago and dot the skyline with cranes.
Thousands of residents want to move downtown, especially to amenity-rich West Loop neighborhoods like Fulton Market, and developers are eager to launch new projects, but some proposals have become too costly after the Fed began raising interest rates in 2022.
“We need cranes in the sky,” said Regina Stilp, founder and principal of Farpoint Development, one of the developers aiming to build a 7 million-square-foot innovation center on the former Michael Reese Hospital site in Bronzeville. “We have a multifamily building (Fulton Market) that we want to build, but we can’t. The cost of construction is too high.”
Fed Chairman Jerome Powell said members of the Federal Open Market Committee had decided to cut the target range for interest rates by 50 basis points, to between 4.75% and 5%, a sharp move after anemic employment growth numbers, coupled with cooling inflationhas sparked fears that the United States could slide into a recession.
“This is starting to move things in a hugely positive direction,” said Aaron Galvin, founder of Luxury Living, a Chicago-based apartment developer.
Lower interest rates boost the economy by making borrowing cheaper, which helps consumers buy new cars and homes. Lower interest rates also make it easier for builders to get the construction loans typically needed to finance the construction of new skyscrapers.
“Since the last meeting (in July), we’ve had a lot of data,” Powell said. “We’ve concluded that this is the right decision for the economy and for the people we serve. We’ll move as quickly or as slowly as we feel is appropriate. We’ll take it meeting by meeting. There’s no sense that the committee is in any hurry to do this.”
But the substantial reduction remains a signal from the Fed, said Mark Hamrick, senior economic analyst at Bankrate.
“This is the first in a series of cuts that should be significant next year,” he said.
The Fed has a dual mandate from Congress: to contain inflation while promoting maximum employment, Hamrick added, and if prices continue to rise at a slow pace and the economy does not overheat, Powell will likely advocate further cuts.
“A lot depends on how the macroeconomics perform,” Hamrick said. “But we have to accept that the benchmark rate is going to come down about 200 basis points.”
That could spark a resurgence, said Mary Boehmler, a senior partner in the Midwest business unit of developer Trammell Crow, which secured financing in 2022 for its recently completed Flora Apartments, an apartment tower in Fulton Market, just before rising interest rates put pressure on new development.
“We have seen a significant slowdown in new construction starts over the last 12 to 18 months due to higher borrowing costs, but not necessarily due to a decline in market demand, particularly in the residential sector,” she said.
Construction workers looking for new jobs shouldn’t get their hopes up too much. Wednesday’s decision was necessary, but it will take time for the rate cuts to translate into new contracts.
“There’s going to be some excitement and some deals that will get done, although I don’t think it’s going to trigger a tsunami,” said Richard Traub, a partner at Smith, Gambrell & Russell. “A lot of people are sitting on the sidelines.”
Chicago developers face a few major challenges, Stilp said, including high property taxes, high construction materials and labor costs, and high capital costs. The interest rate cuts only help with the latter, but they should get investors interested in Chicago real estate development again.
“We’ve had to battle a lot of factors since the COVID-19 pandemic,” she said. “We love Chicago, but to attract investors, you have to fight for every dollar invested.”
The Fed cut interest rates to near zero after COVID-19 sent the economy into a tailspin in 2020. Cheap money helped fuel demand in Chicago Downtown apartment boomadding thousands of new units and transforming aging industrial areas such as the West Loop’s Fulton Market into sleek residential neighborhoods. But as inflation spiked after Russia invaded Ukraine in early 2022 and supply chains choked, the Fed raised rates to 5.5% in July 2023, the highest level in more than 20 years.
The Chicago Plan Commission has greenlit dozens of new apartment projects since 2022. But subsequent rate hikes have stifled many financial deals, and the number of units on track to be completed in 2025 has hit a record low.
Developers completed about 2,900 downtown apartments in 2023, and this year they will put the finishing touches on about 3,600, but the underlying financial agreements for those projects were mostly reached before the Fed began responding to spiraling inflation, said Ron DeVries, senior managing director at Integra Realty Resources.
About 500 new units will be added downtown next year, with another 1,500 on track for completion in 2026, below the downtown’s historical average of a few thousand per year.
“The whole pipeline is drying up, and that’s because of what’s happened in the last 18 months in the financial markets,” he said.
Nearly 95% of downtown apartments are occupied, a sign that living near the Loop’s offices, as well as nearby restaurants, waterfront amenities and entertainment options, remains popular, DeVries said. And unlike developers in some Sun Belt cities like Austin and Phoenix, Chicago builders didn’t oversaturate the market during the boom.
The Fulton market promises to be particularly active in terms of development as interest rates begin to fall.
“The city is reinventing itself and if we ultimately get 250 basis points of rate cuts, the Fulton market will be very active,” Traub said. “There are a lot of developers who are eager to make their mark and just need the macroeconomic forces to cooperate.”
Among the Fulton Market projects on the drawing board is a $448 million proposal from Vista Property, approved by the Plan Commission last summer, that would add up to 1,450 units in three towers on Morgan Street between Kinzie Street and the Metra tracks. The Plan Commission also approved plans for 375 N. Morgan St., a 43-story tower proposed by developers Latsko Interests and JDL Development.
Lower interest rates won’t work like magic, DeVries said. Developers will have an easier time getting the loans they need to acquire new development sites and start construction projects, but banks could still require builders to invest more money in new projects.
Before the pandemic, banks were willing to lend enough money to cover 70% to 75% of costs, but now they are only willing to cover 60%, a huge gap for projects that can cost hundreds of millions, he added. Part of the problem is that many office buildings still have huge gaps, and some lenders have seen their real estate loans go bad.
“The real question is: What are the banks going to do?” DeVries said.
Quintin Primo, CEO of Chicago-based Capri Capital Partners, which is part of the firm rebuilding the Loop’s James R. Thompson Center as Google’s headquarters, said that whatever the impact on residential, the revival of other types of real estate will take longer.
“Overall, with real estate being a capital-intensive sector and debt being of critical importance for both existing and new projects, lower interest rates will have a positive effect on the market,” he said. “But I think we still have some way to go before we see a strong recovery in some sectors of the real estate market, such as office and retail.”
Developer Sterling Bay expects much more activity, said Ryan Walsh, director of acquisitions. The company has about 10,000 apartments in its development pipeline, including 6,000 to 7,000 in the Chicago area. While it will take several years for all the projects to be approved and under construction, he now expects investors to be more enthusiastic about looking at potential real estate projects.
“You’ll see five groups bidding on a site instead of two,” he said. “We’ve spent the last year preparing for this moment.”
Originally published:
