The Federal Reserve announced on Wednesday its first interest rate cut since the pandemic, a move real estate developers say could eventually help kick off the construction of new apartment complexes across downtown Chicago and dot the skyline with cranes.
Thousands of residents want to move downtown, especially to amenity-rich neighborhoods in the West Loop such as Fulton Market, and developers have been aching to break ground on new projects, but some proposals got too costly after the Fed began hiking interest rates in 2022.
“We need to have cranes in the sky,” said Regina Stilp, founding principal of Farpoint Development, one of the developers aiming to build a 7 million-square-foot innovation hub on the former site of Michael Reese Hospital in Bronzeville. “We have a (Fulton Market) multifamily that we want to get in the ground but can’t. The cost of construction is too much.”
Fed Chair Jerome Powell said Federal Open Market Committee members decided to cut the target range for interest rates 50 basis points to between 4.75% and 5%, a strong move after anemic job growth numbers, coupled with cooling inflation, sparked fears the U.S. could fall into a recession.
“It starts to move the needle in a tremendously positive direction,” said Aaron Galvin, founder of Luxury Living, a Chicago-based apartment developer and manager.
Rate cuts goose the economy by making it cheaper to borrow money, helping consumers purchase new cars and homes. Lower rates also make it more affordable for builders to obtain the construction loans typically needed to underwrite new skyscrapers.
“Since the last meeting (in July) we have had a lot of data come in,” Powell said. “We concluded this was the right thing for the economy and the people we serve. We’ll move as fast or as slow as we think appropriate. We’re going to take it meeting by meeting. There’s no sense that the committee is in a rush to do this.”
But the substantial cut is still a signal from the Fed, said Mark Hamrick, senior economic analyst for Bankrate.
“This is the first in what are likely to be meaningful reductions in the next year,” he said.
The Fed has a dual mandate from Congress, to keep a lid on inflation while promoting the maximum level of employment, Hamrick added, and if prices keep increasing at a slow rate and the economy doesn’t overheat, Powell will likely advocate further cuts.
“So much is dependent on the performance of the macro economy,” Hamrick said. “But we need to get our heads around the fact that the benchmark rate will decline by about 200 basis points.”
That could spark a resurgence, said Mary Boehmler, senior associate for the Midwest Business Unit of developer Trammell Crow, which secured financing in 2022 for its just-completed Flora Apartments, an apartment tower in Fulton Market, just before rising interest rates put the squeeze on new development.
“We have been tracking a significant slowdown in new construction starts over the past 12 to 18 months as a result of higher borrowing costs, though not necessarily due to decreased market demand, especially in the residential sector,” she said.
Construction workers eager for new jobs shouldn’t get their hopes up yet. Wednesday’s step was necessary, but it will take time for rate cuts filter down into new deals.
“It will get people a little excited, and some deals will get done, though I don’t think it will trigger a tsunami,” said Richard Traub, a partner with Smith, Gambrell & Russell. “A lot of people are on the sidelines.”
Stilp said Chicago developers face a few big problems, including high property taxes, the high costs of construction materials and labor, and the high cost of capital. Interest rate cuts only help with the last, but they should entice investors to once again start looking at Chicago development.
“There are so many factors we’ve been battling since COVID,” she said. “We love Chicago, but to get investors into Chicago, you have to fight for every dollar.”
The Fed cut interest rates to near-zero after COVID-19 crashed the economy in 2020. Cheap money helped fuel Chicago’s downtown apartment boom, adding thousands of new units and transforming aging industrial areas such as the West Loop’s Fulton Market into sleek residential neighborhoods. But when inflation spiraled after Russia invaded Ukraine in early 2022 and supply chains choked, the Fed hiked rates to 5.5% by July 2023, the highest in more than 20 years.
The Chicago Plan Commission has given the green light to dozens of new apartment plans since 2022. But subsequent rate hikes squelched many financial deals, and the number of units on track for completion in 2025 hit a historic low.
Developers completed about 2,900 downtown apartments in 2023, and this year will put the finishing touches on about 3,600, but the financial deals underlying those projects were mostly arranged before the Fed began responding to spiraling inflation, said Ron DeVries, senior managing director at Integra Realty Resources.
Roughly 500 new units will be added to downtown next year, and another 1,500 are on track for completion in 2026, fewer than downtown’s historic average of a few thousand per year.
“The whole pipeline is going dry, and that’s because of what’s happened over the last 18 months in the capital markets,” he said.
Nearly 95% of downtown apartments are occupied, a sign that living close to Loop office jobs, along with the restaurants, waterfront amenities and entertainment options nearby, remains popular, DeVries said. And unlike developers in some Sun Belt cities such as Austin and Phoenix, Chicago builders did not oversaturate the market during the boom.
Fulton Market promises to be especially active with development as interest rates start to decline.
“There is a reimagining of the city going on, and if we end up eventually getting rate cuts totaling 250 basis points, 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 macro-economic forces to cooperate.”
Fulton Market projects on the drawing board include a $448 million proposal by 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.
Cutting interest rates won’t work like magic, DeVries said. Residential developers will find it easier to get the loans needed to acquire new development sites and break ground on construction projects, but banks may still require builders to invest more money into new developments.
Before the pandemic, banks were willing to loan enough money to cover 70% to 75% of the costs, but now 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 properties still have huge vacancies, and some lenders have seen their office loans go sour.
“The real question is, what are the banks going to do?” DeVries said.
Quintin Primo, CEO of Chicago-based Capri Capital Partners, part of the venture reconstructing the Loop’s James R. Thompson Center into Google’s headquarters, said that whatever its impact on residential, reviving other types of real estate will take more time.
“Overall, since real estate is such a capital-intensive business and debt is so critically important to existing as well as new developments, lower interest rates overall will have a positive effect on the market,” he said. “But I think we still have a way to go before we’ll see a robust recovery in certain sectors in the real estate market like office and retail.”
Developer Sterling Bay expects much more activity, said Ryan Walsh, principal of acquisitions. The company has about 10,000 apartments in its development pipeline, including between 6,000 and 7,000 for the Chicago area. Although it will take several years to get them all approved and underway, he now expects investors to show more excitement when checking out potential real estate projects.
“You’ll see five groups bid on a site instead of two,” he said. “We’ve spent the last year getting ready for this moment.”