Home Prices to Stay High Despite Potential Rate Reductions

Persistently low housing inventory, soaring home prices, and growing concerns over employment statistics suggest that even if the Federal Reserve cuts rates in September, U.S. homes will remain prohibitively expensive.

When the Fed cuts rates, mortgage rates don't automatically decrease. The Fed's cuts influence the federal funds rate, which traditionally impacts interest rates in other sectors like mortgages and car loans. However, mortgage rates are more closely tied to the 10-year Treasury bill. Below, you'll find the "spread" between the average 30-year mortgage rate and the market yield of 10-year Treasury bills over the past decade.

Experts agree that mortgage rates must drop below 6% for buyers to return to the market. Earlier in August, rates nearly dipped to the low 6% range before climbing back to 6.5%. Sellers may need an even greater drop before considering reentering the market, where the lock-in effect has been particularly strong over the past year.

"If you look at the jobs report, and the trend continues for another month or two, the economy could slip into a recession," Melissa Cohn, regional vice president for William Raveis Mortgage, told HousingWire. "Will the Fed implement an emergency rate cut? I'm not sure. I think we're in for a few more days of extreme volatility. It's going to be a roller coaster ride, but we haven't reached the tipping point yet."

The Critical Mortgage Rate is 5.25%

Despite market volatility and speculation about an emergency rate cut, a gradual reduction in rates is more likely, which would take time to impact the housing market.

"Even with the first potential rate cut of this hiking cycle likely to happen in September, the federal funds rate will still be in restrictive territory, and further cuts will be needed to restore balance in the housing market," Moody's Analytics economist Nick Villa wrote.

Villa was more precise in his assessment of the housing market's tipping point:

"A 25-to-50 basis point reduction in the 30-year fixed mortgage rate wouldn't be enough to make renting more expensive again. For that to happen, the 30-year fixed mortgage rate would need to drop below 5.25%, based on a median-priced home of $416,900 (second quarter 2024 average)."

Housing Supply is Rising

The Fed began raising rates over two years ago to curb inflation, driving mortgage rates sky-high—reaching 8.03% in October 2023—making it nearly impossible to buy real estate with a mortgage. Sellers remained in place, unable to swap their low rates for higher ones on new homes. A lack of inventory further exacerbated the issue, keeping home prices elevated, driven by rampant inflation, which has finally begun to ease.

"After about 15 years of renting costing more than homeownership, the reverse became true," Villa wrote.

The positive news is that housing supply is increasing. A six-month supply is considered a balanced market. According to NAR data, in January 2022, there was only a 1.6-month supply, meaning it would take just 1.6 months to deplete the housing inventory at the current sales pace. By June 2024, supply had increased to 4.1 months, up from 3.1 months in June 2023.

However, rising home prices remain a challenge. "While lower mortgage rates could unlock more supply, the country faces a structural housing deficit and needs to continue building more homes," Villa noted.

Villa emphasized the supply-demand imbalance as the reason for escalating prices: "Years of underbuilding since the Global Financial Crisis have led to an estimated housing shortage of at least 1.9 million homes."

An Unaffordability Crisis

As a result, those who couldn't buy a home before the 2022 rate hikes now face a difficult choice between rising home prices and increasing rents. Add in soaring insurance and energy costs, and potential buyers find themselves trapped in a vortex of unaffordability.

A recent Zillow index revealed that a typical household with an average annual income of $83,000, buying a median-priced home with 10% down, could expect to spend over 40% of their income on housing costs—well above the 30% financial experts recommend. In more expensive parts of the country, that percentage is even higher.

What the Changing Market Means for Investors

So, what do the affordability crisis and gradual rate cuts mean for investors? For those who own rental properties, it likely means tenants won't be leaving to buy homes in the short term. Saving for a down payment, finding a suitable home, and qualifying for an affordable mortgage will take time.

However, by 2025, if rates drop below a certain threshold and more inventory becomes available, you may see tenants considering homeownership. To mitigate this, consider securing longer leases with reliable tenants in exchange for moderate rent increases. When the time is right, consider refinancing or tapping into your property's equity to fund upgrades that will attract and retain tenants.

Get in the Game

If you're looking to buy investment properties and wondering whether to wait for further rate cuts beyond September, my advice is to buy now—you can always refinance later. The last thing you want is to be sidelined when competition heats up.

Think Long Term

Thinking long term, knowing that refinancing is relatively inexpensive compared to potential price hikes once rates drop, is a good reason to buy and hold. The tax benefits of depreciation and equity appreciation make real estate a solid long-term investment, even if short-term cash flow isn't as high as you'd like. Investing in appreciating areas at the right price is another smart move.

Be Creative to Make Your Numbers Work

What makes real estate intriguing is the many creative ways to increase cash flow to offset rates and allow investors to stay ahead of the market. These strategies include:

Final Thoughts

Whether you're investing in multifamily or single-family properties, most of your competition will analyze cash flow before making offers. Your advantage lies in buying now before others act, waiting for rates to drop significantly.

Investing involves balancing risk and reward. You'll need to weigh the risk of buying early, making the deal work in the meantime, and refinancing later to capitalize on equity appreciation and improved cash flow.

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