Potential unforeseen impacts of the Fed's interest rate reductions may surface in the real estate sector.
The root issue contributing to America's housing affordability predicament involves an unbalanced supply and demand scenario. Basically, there are more individuals seeking to purchase homes than there are properties available for purchase. This imbalance was present even prior to the pandemic, and the situation worsened when demand surged to unprecedented heights. The market became virtually impassable after mortgage rates witnessed a significant increase from historic lows in 2020 to record highs in the previous year.
When the Federal Reserve presumably decreases rates on Wednesday, it should theoretically dismantle the market's rigidness. However, the Fed's effectiveness hinges on how proactively it lowers borrowing costs across the board.
A reduction in interest rates by half a percentage point (while unlikely but not impossible) would send a strong message that the Fed is committed to undoing the "lock-in" effect that makes homeowners with low-interest mortgages hesitant to sell in a high-interest-rate environment. This would result in a substantial influx of existing homes onto the market and help moderate prices.
As Daniel Alpert, managing partner of Westwood Capital, explained to me, this could potentially yield outstanding results in the current post-pandemic cycle. Reducing homeowner expenses would also entice individuals out of the rental market, thereby decreasing rent costs – a perfect situation, in Alpert's words.
However, a more gradual and subtle easing might not prompt homeowners to sell, especially those who successfully secured inexpensive mortgages during the early stages of the pandemic. This is particularly relevant when American house prices persistently hit new highs.
The Federal Reserve can't construct houses, but it can subtly impact the popularity of selling homes by influencing mortgage rates through its benchmark rate. In fact, predictions of a potential rate cut at the upcoming Fed meeting already triggered a decrease in mortgage rates from 6.7% in August to 6.2% last week.
According to Daryl Fairweather, Redfin's chief economist, "If the Fed adopts a more flexible stance, I believe we could get down to around 6%." Even a minimal decrease to 5.9% could have a significant psychological impact on the housing market. This might coax individuals off the fence and dampen the persistent demand for homes.
Meanwhile, potential homebuyers and those who recently bought homes are eager for any reprieve from the high mortgage rates. The latest 6.2% average mortgage rate is, undoubtedly, a better alternative to the dismal 7.8% peak from the previous year, as the difference could translate into savings of hundreds of dollars each month.
Unfortunately, the potential repercussions brought forth by the Federal Reserve's actions this week and beyond could lead to unexpected complications. By solving the demand issue without addressing the supply deficit, the Fed could inadvertently worsen the housing affordability crisis it seeks to resolve.
As Samantha Delouya, one of my colleagues, pointed out this week, a decrease in mortgage rates could prove to be a double-edged sword. In the words of Greg McBride, chief financial analyst at Bankrate, "Be cautious about what you wish for. A drop in mortgage rates could spark a wave of demand, making it more challenging to purchase a home."
The decrease in mortgage rates, as suggested by Redfin's chief economist, could potentially bring down interest rates to around 6%, empowering potential homebuyers and alleviating their burden. However, if the Federal Reserve fails to address the underlying supply deficit in the housing market, the move could inadvertently intensify the affordability crisis by heightening demand.
The economic recovery post-pandemic has shown a significant increase in demand for homes, which has contributed to the soaring housing prices. In such a scenario, reducing interest rates could stimulate business growth in the real estate sector, thereby boosting the overall economy.
