Developments that will impact the industry in the coming months

What can you expect to transpire in the business and financing environment the rest of this year?

We expect the remainder of the year to be volatile as Fed rate hikes continue to slow the economy as a means to combat inflation. We also expect increased volatility in the capital markets, which will translate into volatility in real estate prices.

Additionally, we expect unemployment to rise, but we see higher unemployment disproportionately impacting the lowest wage earners who are already showing signs of weakness through higher credit delinquencies and reduced purchasing power.

On the bright side, the high-end consumer will remain strong throughout the year yet be more price conscious while looking for bargain investment opportunities. High-end consumers will continue to build and invest in real estate, but they’ll look for price concessions and better overall terms because the cost of financing projects continues to rise.

Here’s a deeper look at the notable trends we’re seeing.

Five things to watch

Financing projects today is more challenging for small businesses because of a higher cost of capital. Photo: Olegda88/iStock / Getty Images Plus/Getty Images

1. Financing applications. We have seen tightening across the banking sector since at least the spring of 2022. This tightening accelerated after the failures of SVB and Signature Bank.

As banks pulled back from extending credit to small businesses, we’ve seen an increase in quality applicants who are looking for additional growth capital and are unable to obtain the financing they need from the banking system.

2. The economy. The Federal Reserve seems determined to slow the economy through additional rate hikes until inflation comes under control. As a result, we expect the economy to continue to slow in the coming months. This slowing could place greater strain on the construction industry.

Ultimately, we see the employment rate as the greatest indicator of demand in the construction industry. If unemployment begins to rise, demand for new housing and home renovations is likely to decline.

3. Business loan interest rates. The cost of capital to small businesses has risen at a rate that is likely in line with the rise in the Federal Reserve rate. This has been challenging for businesses that depend on regular financing as a core part of their operations.

Businesses that consistently fund the purchase of inventory or raw materials are especially impacted. An elevated cost of capital also makes the financing of certain new projects and expansion opportunities uneconomic, slowing overall growth.

4. Residential real estate. Higher interest rates are cooling the real estate market across the U.S., but we continue to see strong credit demand from contractors as a shortage of affordable housing, coupled with low unemployment rates, generates demand for new housing stock.

Additionally, higher interest rates mean many homeowners are locked into lower-rate mortgages and are choosing to stay in their home rather than selling and repurchasing in a higher-rate market. As a result, many homeowners are looking to renovate existing housing stock and are thus driving demand for contractors.

While consumer savings has declined significantly from its post-pandemic high, higher earners, by and large, maintained their savings while lower earners burned through much of theirs. With strong rates of employment across all income levels, consumer spending remains elevated. This is especially true for high earners who continued to invest in real estate and home improvement despite a higher interest rate environment.

Still, we do believe the failures of SVB and Signature Bank made high-end consumers more cautious about the overall state of the economy. We would not be surprised to see a further slowdown in high-end real estate purchases – especially if interest rates continue to rise.

5. Expectations for other industry markets. Overall, we believe the shortage in affordable housing across the U.S. will drive demand for multifamily construction for years to come. We are more pessimistic about commercial office space, which we expect to suffer in many major metropolitan areas as remote work becomes a permanent fixture in American life and many long-term corporate leases expire.

All real estate markets will be susceptible to the negative effects of higher interest rates and constrained bank liquidity, which may create significant volatility in real estate prices should another banking shock occur.

Ben Johnston is COO of Kapitus, a provider of financing for small- and medium-sized businesses.

Related: Forecasting construction in the months ahead