Lower Interest Rates Could Actually Be Bad For Real Estate Markets Right Now

Homebuyers and real estate investors are hoping that interest rates come down. But is that what they really want?

The average 30-year mortgage is 6.27%, a healthy decline from being north of 7% in November, but if interest rates go down materially in the next few months it will most likely be because the U.S. economy has fallen into an unattractive recession that reduces the demand for real estate.

There has not been demand destruction for real estate overall since the Great Financial Crisis. With the exception of the gut punch the office market took because of COVID-19 and the retail sector’s ongoing battle versus e-commerce, demand for real estate has been up and to the right for almost 15 years.

Even after the failure of a number of sizable banks that shook the global financial system, recession and material job losses are the only likely culprits of the Fed changing its current trajectory of raising or keeping interest rates at current levels (outside of another COVID-style pandemic or an uncanny war).

I believe the most desired and more reasonable outcome for homebuyers and investors alike may be current interest rates and stable demand rather than lower interest rates coupled with lower demand.

Homebuyers and real estate investors that say they really wish interest rates would come down, don’t realize the other side of that coin is not very attractive.

The Housing Market Cooled Because Rates Are Up, But for How Long?

Let’s be clear: the housing market cooled down over the past year but is already showing signs of perking up this spring. After declining for 7 of the last 9 months, housing starts surprisingly jumped 10% (annualized, MOM) in February 2023. In fact, numerous pundits and surveys of demand suggest that the market is getting better for U.S. housing.

You should know that current housing market conditions aren’t perfect, but inventory is very low, which means that the making of yesteryear’s bubble isn’t at play. Even after sales dropped 20-30% last year there are less than 3 months of existing homes for sale on the market vs. a traditional average of 6 months.

And the path to higher inventories of homes, which was a real problem in 2006-10, is not an issue today. In February 2023, there were 412,000 open construction positions around the country, one of the highest number of openings since the Bureau of Labor Statistics began reporting that data decades ago. There really is no ability to overproduce housing in a real way with the current dynamics of the U.S. economy and job markets.

So what’s the next step? What’s going to give? If people still need a place to live and can afford a reasonable place because they have a job (i.e., the economy hasn’t completely faltered), they will wait and rent a little longer if they are not tired of waiting from the pause of 2022.

If there are no dramatic job losses in the U.S. economy, which are necessary for rates to go down materially, inflation will likely continue for high-quality rental properties. This means that consumers are still going to need to make a decision between the fixed costs of a mortgage and the increasing cost of living in a rental.

If rent inflation is remotely elevated and inventory remains lackluster, demand for homes to buy will likely increase without a reduction in interest rates.

To Buy or Not to Buy: What Should You Do?

When it comes to buying a home, the main thing to do right now is to remain rational and balanced. A home is an investment and shelter. If all the right elements are in place for you — the right school district, the right neighborhood for your family, and the kind of home you’re really looking for — it’s a good time to consider purchases and investments because the risk and the reward feel more balanced than they did before the market took the massive shocks of the pandemic, war, aggressive interest rate increases, and global bank failures.

For investors, you’ll need to respond to the current market conditions by taking a close look at a few critical factors including the property type (multi-family, build-to-rent, and single-family rentals are not the same right now), lender’s terms, and your need to deploy cash.

What’s true in each case is that the interplay between mortgage rates, rent inflation, price inflation, and the availability of homes is more intriguing for astute buyers than it was when all boats were rising because prices were going straight up. In other words, this is a great time for opportunistic investors who can add value.