The Fed Cut 50 Bps. Now What?

“Is that enough of a rescue? It would partly depend on how much of a spread lenders decide to maintain. This move could lower borrowing costs and stimulate economic activity, including commercial real estate. However, the impact on asset values is complex. At the same time, lower rates generally make financing more affordable. Still, the extent to which this will drive up property prices remains uncertain, especially given the Fed’s cautious approach to inflation.”

-Doug Ressler, Senior Research Officer at Yardi Matrix

Hi Nuvo Community,

The Fed's Dilemma: Rate Cuts at a Critical Juncture

On September 18, 2024, the Federal Reserve cut interest rates by 50 basis points, and the market expects another 50bps cut by the end of the year (Coincidentally, they also cut 50bps on September 18, 2007). The timing and size of this cut raises concerns about underlying economic weaknesses. If this is a soft landing, why do we need a 50bps cut right off the bat? Furthermore, this first cut seems to be largely “priced in” by the markets, with many already expecting a 50bps cut in the days leading up to September 18th. The impacts may be muted.

The Real Estate Perspective

Real estate professionals have been closely watching the Fed’s rate cuts, hoping for relief from higher borrowing costs. Lower interest rates should, in theory, bring down mortgage rates and make financing more affordable, spurring investment and transactions across residential and commercial real estate markets. However, this expectation comes with a significant caveat: rate cuts alone are not enough to guarantee a recovery in real estate activity—especially if broader economic conditions remain uncertain.

One of the key lessons from the Global Financial Crisis and subsequent quantitative easing (QE) programs is that cheap money doesn’t always translate into readily available credit. During the post-2008 recovery, despite historically low rates, banks remained cautious, tightening their lending standards, particularly in commercial real estate. A similar dynamic could play out in 2024/25. Even with lower rates, lenders may restrict access to credit, as they are already dealing with troubled loans on their books.

Housing Affordability: Will Lower Rates Help or Hurt?

In the residential real estate market, the impact of lower rates is more nuanced. On the one hand, rate cuts tend to lower mortgage rates, making it cheaper for prospective homeowners to finance a purchase. However, in today’s housing market—already plagued by high prices and low supply—this could exacerbate the housing affordability crisis rather than alleviate it.

1. High Housing Inflation:

Lower mortgage rates typically increase housing demand as more buyers can afford homes at lower interest rates. But with housing inventory already tight, increased demand could lead to further price inflation in the housing market, especially in hot markets where affordability is already a major concern. Instead of making housing more affordable, lower rates may simply push prices higher, locking even more potential buyers out of the market.

We’ve seen this dynamic before—following the COVID-19 pandemic, when interest rates were slashed to historic lows, the housing market experienced a boom in prices. While more buyers could qualify for loans, the increased competition and limited supply led to skyrocketing home values, worsening the affordability crisis for many households. This time around, supply is already historically low.

2. Limited Relief for Renters:

For those unable to buy, the impact of rate cuts on the rental market is less clear. While lower interest rates may make it cheaper for developers to build multifamily housing, the time lag between rate cuts and new construction projects coming to market means short-term relief for renters is unlikely. In the meantime, rental prices—particularly in high-demand areas—could remain elevated, as more people are priced out of homeownership and forced to rent.

Market Reactions: Labor Data and Volatility

If the labor market continues to weaken, a larger rate cut in response may trigger market volatility, as investors interpret the move as the Fed signaling that the economy is in deeper trouble than previously thought. On the other hand, if jobs data shows resilience and inflation remains in check, the Fed may be forced to pull the rug out from the market’s expectation of future cuts.

Implications for Real Estate

While the real estate industry might expect lower rates to benefit investment and transactions, the actual outcomes could be more complicated:

1. Tight Credit Conditions: Even with lower rates, lending standards may tighten if banks perceive growing risks in the economy. This was the case throughout the Global Financial Crisis, where lower rates didn’t result in more lending.

2. High Housing Inflation: In the residential market, lower mortgage rates may further stoke housing inflation, as more buyers compete for the limited number of homes available. This could keep home prices elevated, making it harder for first-time buyers to enter the market, even as mortgage rates decline. Housing is a major component of inflation. Stubbornly elevated costs may keep headline inflation high and remove some of the Fed’s justification for further cuts.

3. Rental Market Stagnation: While multifamily housing developers could benefit from cheaper financing, the long lead times associated with construction mean rental relief may not materialize quickly. Renters could continue to face high costs as the oversupply gets absorbed over the next 1-2 years, especially as more would-be homeowners are forced to remain in the rental market due to unaffordable home prices.

Conclusion: Time Will Tell, but Volatility is Pretty Likely

Ultimately, the real estate market’s response to the Fed’s rate cuts will depend on broader economic conditions. In the short term, real estate pros are cheering on rate cuts. If that sentiment turns to concern of a downturn, the benefits of lower rates may be overshadowed by the risks of tighter credit and investor caution. As history has shown, cheap money doesn’t always lead to more lending.

All the best,

Yuri - Your Real Estate Investigator

Credit: Brian Underdahl, Chief Executive Officer, Nuvo Capital Partners

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