How interest rate cuts impact the housing market

As we inch closer to the Federal Reserve’s next policy meeting on September 17th and 18th, 2024, the financial world finds itself buzzing with speculation. And everyone is whispering the same word: cuts.

Yes, the Fed might just cut those interest rates. And if they do, it won't just be a headline…

It will be a market-moving event with sweeping implications, especially for the real estate landscape【U.S. News & World Report, 2024】.

So if you’re in the business of real estate, or even just considering dipping your toes in the water, you cannot afford to ignore what happens next.

But before we dive into the finer points, let's first understand the 'why' behind such a decision.

Spoiler alert: It’s not just because Jerome Powell had a rough day at the office.

Why interest rates, inflation, and unemployment matter together

When we talk about the economy, three terms dominate: inflation, interest rates, and unemployment. 

These three factors are interconnected and affect nearly every aspect of your daily life, from your paycheck to the price of your morning coffee. 

Understanding their connection to the economy is key to seeing why a potential rate cut by the Federal Reserve is such a hot topic. Let’s dive in:

• Inflation: Lowering interest rates is one way to encourage spending, which can help keep inflation within a target range. Recently, the U.S. inflation rate dropped to a three-year low of 2.5% which is almost in line with the US Federal Reserve's target of 2% per year【CBS News】. Increased inflation means prices rise too fast, making everything more expensive【Investopedia】.
• Unemployment: Lower interest rates can help create jobs by making it cheaper for businesses to borrow money, expand, and hire more workers. For example, after the sharp increase in unemployment to 14.9% during the pandemic in April 2020, rates were cut to encourage job growth, helping bring the unemployment rate back down to 4.2% by August 2024【BLS】.
• Interest rates: Central banks adjust interest rates to control both inflation and unemployment. In response, the Federal Reserve is expected to cut interest rates by 25 – 50 basis points (0.25% – 0.5%) to keep the economy moving. Lower interest rates mean cheaper loans, which usually leads to more spending and investment 【Economic Times】.

Historical context: Interest rate changes and their impact on the housing market

To better understand how interest rate cuts affect markets, let's look at historical examples:

These examples show how interest rate cuts have historically been used to stimulate economic growth, particularly in times of crisis or economic slowdown【Forbes Advisor】. 

But enough about the broader economy; let's zoom back in on the housing market

The impact of interest rate cuts on the housing market

When the Federal Reserve cuts interest rates, it sets off a chain reaction across the entire real estate market, directly affecting mortgage rates, home prices, and the overall housing demand.

1. Financing costs

Interest rates are a key determinant of mortgage rates, and when the Fed cuts rates, mortgage rates typically follow suit. 

This creates a more favorable borrowing environment, making it cheaper for both homebuyers and real estate investors to finance their purchases.

• Increased affordability: A reduction in interest rates typically lowers monthly mortgage payments, making homeownership more accessible to a broader range of buyers. For instance, a 0.25% – 0.5% reduction in the interest rate on a 30-year mortgage can result in savings over the loan term【Bankrate, 2024】.

For instance, a 30-year mortgage of $300,000 based on a 0.5% cut:

• At an interest rate of 5.25%, the monthly payment would be approximately $1,656.61
• At a reduced interest rate of 4.75%, the monthly payment would be approximately $1,564.94

The difference in monthly payments is around $91.67. Over the entire 30-year term, this 0.5% reduction in interest rates would result in a total saving of $33,000.87

• Impact on investor behavior: Lower financing costs also make it easier for real estate investors to secure loans for new projects or refinancing existing properties.【Jones Asset Management, 2023】.

2. Property values: A surge in demand drives prices up

As borrowing becomes more affordable, the demand for real estate often increases, leading to higher property values. This is particularly true in markets where housing supply cannot keep pace with the growing demand.

• Rising home prices: Lower interest rates can cause a surge in homebuying activity, pushing up property prices. For example, during the low-interest rate environment of 2020 and 2021, median home prices in many markets saw record-breaking increases【RealWealth, 2024】.
• Investment opportunities: For real estate investors, this creates opportunities to capitalize on rising property values. Investors who purchase properties in a low-rate environment can benefit from both the appreciation in property values and potentially higher rental incomes as demand for housing increases【Jones Asset Management, 2023】.

How investor behavior shifts when interest rates change

Interest rate changes don’t just affect homebuyers and businesses; they also have a significant impact on how people and institutions choose to invest. 

A recent study by Lahav and Benzion (2022) showed that investors tend to react asymmetrically to changes in interest rates:

• When interest rates decrease: Investors tend to diversify and expand their portfolios during such situations. This means they allocate more money to different asset classes like stocks or real estate, which have the potential for higher returns, rather than lower-yield investments like government bonds.

This has profound implications for how portfolios should be managed during periods of changing interest rates.

Lessons from real estate moguls during rate cuts

When interest rates drop, the smartest investors don’t sit on their hands; they seize the moment…

Here’s a closer look at how worldwide savvy investors maximized gains by leveraging lower interest rates for significant returns.

3 Practical steps for real estate investors in a rate-cut environment

If the moguls haven’t made it crystal clear on how to act; don’t worry we got you covered!

If you're a newbie to real estate, here are 3 investment strategies to get you on track.

And if you need a quick guide, think of the following points as your cheat sheet for navigating the twists and turns of a potential rate cut – straight from the experts:

1. Lock in financing early: With rates expected to drop, securing a mortgage or refinancing existing loans before rates hit their lowest point can save you money in the long run. Consider locking in a fixed-rate mortgage to protect you from future rate hike【Bankrate, 2024】
2. Focus on high-growth markets: Identify markets where property values are likely to appreciate rapidly due to increased demand and limited supply. These areas often offer the best opportunities for both capital gains and rental income growth【Jones Asset Management, 2023】. For example, you might explore UAE’s market by researching the best neighborhood guides for investment or better understand what attracts property investors to Dubai’s hot market to make an informed decision. 
3. Consider property value-add strategies: Investing in properties that offer opportunities for improvements or renovations can increase their value, especially in a rising market. This strategy not only boosts the property’s resale value but can also justify higher rental rates【RealWealth, 2024】 

Why you should care about interest rate cuts

Interest rate cuts are more than just adjustments made by central banks—they are powerful tools that shape the entire economy. 

As we await the Federal Reserve’s decision this week, now is the time to prepare. Whether you’re looking to expand your portfolio, secure better financing, or capitalize on rising property values, staying informed and proactive is key to success in this dynamic environment.

Ready to make your move in real estate? Explore Dubai Properties now.

References:

• Investopedia: What Is Inflation and How to Control Inflation Rates
• Yahoo Finance: Interest Rates Expected to Fall in September 2024
• Morningstar: Historical Impact of Interest Rate Cuts on Markets
• Why it's the perfect time for the Fed to go big on rate cuts
• Federal Funds Rate History 1990 to 2024
• Bankrate: Current Mortgage Rate Trends and Predictions
• Bankrate's Mortgage Guide
• RealWealth's Housing Market Predictions
• Jones Asset Management
• RealWealth's Guide
• The Real Deal
• The World Property Journal
• Business Insider
• The Wall Street Journal Profiles Blackstone’s Firmwide Growth and Thematic Investing Strategy