Even If the Fed Cuts Rates, Homes Will Still Be Just as Expensive

Stubbornly low housing inventory, high home prices, and increasingly worrying employment stats mean that despite the likelihood of a September Federal Reserve rate cut, U.S. homes will still be far too expensive.

Mortgage rates do not automatically drop when the Fed announces a rate cut. The Fed’s cuts determine the federal funds rate. Traditionally, interest rates in other sectors, like mortgages and car loans, have followed their lead, adjusting accordingly, but mortgages specifically tend to track the 10-year Treasury bill. Below, you’ll see the “spread” between the average 30-year mortgage rate and the market yield of 10-year Treasury bills over the last decade.

For buyers to jump back into the market, experts agree that rates need to fall below 6%. It got close earlier in August when rates fell to the low 6s but have since climbed back to 6.5%. It might take even more of a drop for sellers to come back to the market, where the lock-in effect has been as stiff as can be for the last year.

“If you look at the jobs report, and that trend goes on for another month or two, the answer is yes: The economy will go into recession,” Melissa Cohn, regional vice president for William Raveis Mortgage, told HousingWire. “Will the Fed come and do an emergency rate cut? I don’t know. I think we get a few more days of extreme volatility. We’re going to be very much in a roller coaster. But we haven’t fallen off the cliff yet.”

The Tipping Point Is a Mortgage Rate of 5.25%

Despite Wall Street volatility and speculation of an emergency rate cut, a gradual lowering of rates is likely, which would still take time to have the desired effect on the housing market.  

“Even with the first potential rate cut of this hiking cycle likely to occur in September, the federal funds rate would still be in restrictive territory, with additional cuts needed to help restore the housing market to a more balanced equilibrium,” Moody’s Analytics economist Nick Villa wrote. 

The data expert was more specific regarding his opinion on a housing market tipping point: 

“A 25-to-50-bps reduction in the 30-year fixed mortgage rate would not be enough to turn the tables such that renting becomes more expensive again… Roughly speaking, the 30-year fixed mortgage rate would need to drop below 5.25% for this to occur, based on a median-priced home of $416,900 (second quarter 2024 average).”

Housing Supply Is Up

The Fed started raising rates to curb inflation over two years ago, sending mortgage rates sky-high—at one point in October 2023, reaching 8.03%, slamming the door on the viability of buying real estate using a mortgage. Sellers stayed put because even if they did manage to snag a buyer, they could not trade in their low rate for a higher one in a new home. Further exacerbating the issue has been a lack of inventory, which also kept home prices soaring, buoyed by rampant inflation, which finally has come down.

“After roughly 15 years of the cost of renting exceeding the cost of homeownership, the converse became true,” Villa wrote.

The good news is that housing supply is increasing. Six months of supply is considered a balanced market. According to NAR data, in January 2022, there was only 1.6 months’ supply, meaning that it would only take 1.6 months to deplete the supply of houses at the current sales pace. By June 2024, it had jumped to 4.1 months of supply, up from 3.1 months in June 2023. 

However, the spanner in the works is increasing home prices. “While lower mortgage rates are one possibility that could unlock more supply, at the end of the day, the country has a structural housing deficit and needs to continue building more homes,” Villa wrote.

Villa underscored the supply-versus-demand 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.”

A Vortex of Unaffordability

The result has been that people who were unable to buy a home before the rate hikes of 2022 have had to choose between increasing home prices or rents. Throw in additional expenses, such as skyrocketing insurance and energy costs, and potential buyers have found themselves in a vortex of unaffordability.

A recent Zillow index showed that the typical household with an average household income of $83,000 a year, buying a median-priced home with 10% down, could expect to spend more than 40% of their income on housing costs. That’s well over the 30% that financial experts recommend. And in pricier parts of the country, that percentage increases.

What the Changing Market Means for Investors

So what do the unaffordability crisis and gradual rate cuts mean for investors? For those who currently own rentals, it means that you most likely will not see your tenants vacate your buildings to buy houses in the short term. Saving for a down payment and then finding a home and qualifying for an affordable mortgage should take a while. 

However, at some point in 2025, if rates do cross a threshold and more inventory is available, you might see tenants looking to buy. To offset this, look for deals with good tenants for longer leases in return for moderate rent increases. Also, when the time is right, consider refinancing or tapping into your property’s equity to perform upgrades that will maintain and attract tenants.

Get in the game

If you’re looking to buy investment properties and wondering if you should wait for further rate cuts beyond September, my advice is to buy now—you can always refinance. The last thing you want is to get lost in the shuffle when competition heats up. 

Even if you don’t quite have enough of a down payment saved up, look for creative ways to get your first property. These could include:

• Buy with a partner who also contributes down payment money.
• Look for seller financing.
• Consider a hard money loan and strategize a refinance when equity is higher and rates are lower.
• Liquidate assets (401(k)s, HELOCs, cars, etc.).
• Consider moving into the home initially to qualify for an FHA 3.5% down payment. This could be done on a two-to-four-unit property so that a tenant would help offset the mortgage payment. Once you move out, you can rent the entire place and repeat the process.

Think long term

Thinking long term, knowing that a refinance is relatively inexpensive compared to the price hikes that are likely to occur once rates drop is a good reason to buy and hold. The tax benefits of depreciation and equity appreciation always make real estate a good long-term investment, even if cash flow in the short term is not as high as you would like. Investing in the right areas (which are appreciating) for the right price is another savvy move.

Be creative to make your numbers work

What makes real estate fascinating is that there are so many ways to be creative to increase cash flow to offset rates and allow investors to make moves to stay ahead of the market. These can include:

• Charging for parking
• Installing commercial pay-for-use washer-dryers
• Rent by the room
• Construction loans (from community banks) or FHA 203(K) loans that convert to regular mortgages, allowing you to buy discounted fixer-uppers without refinancing
• Owner-occupied financing with a low down payment
• Short-term room renting that does not violate owner-occupied financing rules
• Billboard advertising for your commercial property.  

Final Thoughts

Whether you’re a multifamily or single-family investor, most of your buying competition will do their cash flow analysis to ensure the numbers work before making offers. Your advantage will be in buying now before others have pulled the trigger, waiting for rates to fall substantially. 

Investing is a game of risk versus reward. You will have to consider the risk of buying early, making the deal work in the interim, and refinancing to take advantage of equity appreciation and cash flow.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.