The US Federal Reserve, on March 15th 2020, reduced the federal funds rate by a total of 1.5%, bringing it down to 0% – 0.25% for cushioning the economic impact of COVID-19. The Federal funds rate is the interest rate at which depository institutions, like banks and credit unions, lend reserve balances to other depository institutions overnight. This measure was last used during 2008-2009 financial crisis to incentive the US economy. The impact of coronavirus on the economy is inevitable, however, developers can now benefit from the 0% federal rate for low interest rates. To answer the popular misbelief regarding loans, the reduction in federal funds rate does not mean 0% business and mortgages are available. However, the interest rates in general will drop which brings 2 benefits for real estate developers:
Borrow money for building projects at a lower cost.
Lower mortgages which incentives home purchasing.
The 0% federal funds rate offer an opportunity for real estate developers to develop projects with lower ownership cost during their service life. Also, by implementing energy efficiency measures, water conservation, and on-site renewable energy generation, developers can further reduce the building operating costs. Existing building owners can also benefit from the reduces fed funds rate by availing lower interest rates for building upgrades and renovations.
Starting Pre-Construction During COVID-19 Outbreak
With the help of modern design software and advanced collaborating tools, buildings can now be designed, reviewed and finalized without physical meeting. Developers can have virtual meetings with architects, engineers, design team, and also bank and law firms during every stage of the building project lifecycle. Thus, developers can start building projects even during emergency situation like coronavirus outbreak while ensuring all the construction requirements and prerequisites are met.
Thanks to the 0% federal funds rate, developers can obtain attractive financing terms from the banks. Additional benefits like zero-interest grace periods can be offered by some financial institutions in addition to low interest rates. Homeowners can also avail benefits as the Home Equity Line of Credit (HELOC) will also drop due to 0% federal rate. This type of loans is an excellent option for building renovation projects. Credit card rates will also drop slightly and offer further savings for homeowners who use them. HELOC can also be used for building upgrades like energy and water conservation or solar panels installation.
How 0% Federal Funds Rate Affects Loans
During early 2019, the fed fund rates were 2.5% which results in a prime rate of 5.5%. Following the drop in March 2020, the fed fund rate is 0% – 0.25% which results in a prime rate of 3.25%. In order to visualize how this affects the construction project loans let consider an example. Assume a developer is planning a $50 million project. The monthly payments for a 10 year tenure loan with 2019 prime rate and the current prime rate are compared below:
At the interest rate of 5.5%, the monthly payment is $542,631.39
At the interest rate of 3.25%, the monthly payment is $488,595.14
As you can see, the monthly payment with the current prime rate is reduced by $54,000. The total savings during a 10 year tenure would accumulate close to $6.5 million. This is a simplified example, but it demonstrates the concept. As mentioned earlier, these savings can go higher if the project includes energy efficiency measures, water conservation measures, renewable energy systems like solar panels. COVID-19 will delay the construction projects, but choosing the right engineering team will not only result in cost savings, but also introduce a permanent effective strategy for construction projects as we move ahead.
