Heard faintly over the last few months, it’s not a siren song, but the sound of bubbles of a red herring: at long last, the Federal Reserve is expected to cut interest rates.
The Fed raised interest rates quickly in 2022 and 2023 in an effort to curb inflation, which had ballooned above 9 percent—the highest inflation seen since the 1980s. These rate spikes and other factors effectively ended more than a decade of construction activity in Utah and much of the nation. Now with inflation much closer to its target of 2 percent, the Fed is expected to begin ratcheting back down rates when it meets on Wednesday.
While the cuts will be welcome news for everyday consumers who saw the cost of credit cards, car loans, mortgage rates and home equity loans spike, it likely won’t be enough to make many commercial real estate deals pencil in the short-term, developers and brokers told Building Salt Lake.
Sources say the high cost of construction and supply of new housing are difficult to overcome, and the expected cuts won’t fix the fundamentals for developers in Salt Lake’s multifamily construction market. Instead, construction costs and rental demand need some settling time for new development to emerge, even as overall housing demand in Utah remains high.
Supply Beats Demand
“If you study this in 10 years, you’ll probably see a strong relationship between cheap money and opportunity zones,” said Dejan Eskic, senior research fellow at The Kem C. Gardner Policy Institute.
Salt Lake County maps of the formal opportunity zones overlaid with the multifamily development pipeline proves Eskic’s overall point, with a hefty percentage of recently completed and emerging projects found in these areas. Everyone was willing to play the multifamily development game and capitalize on an unmet demand bellied by low interest rates.
It was a deluge as Utah finally outpaced housing demand, shrinking the overall shortage in 2017 in half by 2022. The good news continued into the very end of last year, too, as the fourth quarter of 2023 had the highest net number of executed leases on record, according to Mark Jensen, managing director and broker for Northmarq Multifamily.
While not a renter’s paradise, tenants in Utah have options like never before. Many new apartments are offering eight weeks of free rent, on average—a 15% haircut in price on a 12-month lease—as property managers compete with each other to fully lease up and receive permanent financing once new buildings are complete.
It’s ideal for a renter looking for a new place, but can an interest rate cut put developers back in the driver’s seat and new development in the ground?
Vacancy
All those interviewed for the story noted that the chatter around interest rates isn’t where attention is needed. Instead, it belongs with absorption and vacancy rate.
With 5,100 deliveries over the last 12 months and 4,600 of those units rented over the last 12 months, absorption is solid, according to Patrick Bodnar, senior vice president for multifamily properties at CBRE, especially in the newly completed projects in Salt Lake City’s Downtown.
But, Bodnar cautioned, this could be a result of displacement from other existing apartments. Data from the St. Louis Fed showed Utah’s vacancy rate climbing to 5.3% last year; CBRE reported in their Q2 2024 Multifamily Report for Salt Lake City that vacancy is now 6.1%.
Is it all doom and gloom for new development? Not quite.
Interest Rate Cuts Help…
According to Bodnar, the rate cuts will help, even if they are already priced into many recent deals. There will be an adjustment, and an enthusiasm to transact existing buildings, but new projects might have to wait.
Jensen echoed a similar comment.
“There are a lot of pent up deals that were not in a position to move forward, or projects sidelined due to capital markets and fundamentals,” Jensen said.
As of right now, Jensen said, the risk profile is still too high to utilize institutional dollars and get shovels in the ground to bring up the next spate of multifamily projects.
Even if this is a tough period for Walker Wood, VP with CW Group, and other developers, he said this a healthy change from the rent spikes of previous years with vacancy rates hovering around 3 percent. Demand for housing is still high, optimism bellied by data from the Kem C. Gardner Policy Institute that shows that Utah is still 37,000 units short of meeting demand.
The case in point for both brokers is that the supply will slow as deliveries taper off mightily in the coming two to three years from these record highs, with Jensen saying that it may be 24 months before a truly new project enters the construction pipeline.
More Promising News
Much like interest rates being just one of many variables in new development, supply chain issues and their effects on construction costs led to too many unknowns of years past—but surety is arriving.
“We’re coming out of the danger zone,” said Jensen, especially as the cost of construction settles to a more palatable level, with Jensen reporting a 7 percent decrease locally.
With the 2034 Winter Olympics, downtown revitalization projects, and other generational projects planned around the state, development tailwinds are emerging.
“It’s expected that Salt Lake will have a robust comeback, said Bodnar, especially given the in-migration and overall lack of supply per capita. “We have a glut right now, but as it subsides and we become supply constrained,” he and his team have been told 4-5 percent rent growth is on the horizon a year from now.”
All were confident that signs throughout the multifamily market are promising, even if we’ve hit a development wall. We just need time to see how we’ll climb over.
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