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The Unintended Consequences of Rate Cuts on the Housing Market in the US - by The Haptic Market Lens

  • the haptic investor
  • 11. Okt. 2024
  • 6 Min. Lesezeit



As we approach the expected rate cuts in September, the consensus is that this will be a welcome relief for the US housing market, potentially boosting residential real-estate prices. However, we challenge this notion and propose an alternative scenario. To understand our perspective, let's revisit the housing market's recent history.


From 2020 to 2022, the US housing market experienced a remarkable surge, with cities like Austin and Miami leading the charge. Buyers were eager to purchase, and bidding wars became common. The combination of affordable interest rates, ample free cash flow, and rising home prices created a perfect storm that fueled the market. Existing homeowners benefited from significant equity boosts when selling their properties, while income growth and government stimulus packages, such as the CARES Act and the American Rescue Plan (bipartisan, by the way), put more money in people's pockets.


This excess cash flowed into various assets, including housing and other assets. One is reminded of the Meme Stock craze and wild Crypto markets. Housing in the residential sector is of course, primarily a basic need - at least for private households. Therefore, we refer to the price development, not to the market environment or market mechanisms.



However, as the market continued to rise, people were priced out of their preferred price range and took on loans that were tight on their budget. The long duration of US mortgages (typically 30 years) means that interest rate changes have little impact on existing homeowners. Instead, rising interest rates primarily affect new home buyers, reducing the affordability of property. As expected, when rates increased significantly in April 2022, new privately-owned housing construction plummeted.


Fast-forward to the current situation, where the housing market is facing a unique form of illiquidity. The sharp rise in interest rates has created a significant bid-ask spread, making it challenging for buyers and sellers to agree on prices. Homeowners who secured low-interest-rate mortgages years ago have effectively "shorted bonds," embedding equity into these "short bond" positions. This equity is tied to the specific home and is not transferable to a new buyer, who would have to finance at the higher current rates.


As a result, the fair value of the asset (the home) is different for existing homeowners versus new buyers. Homeowners may be reluctant to sell, as they would have to give up this valuable low-interest-rate mortgage, which can represent a significant portion of the home's value. If rates rise, this "shadow equity" becomes more valuable, making it even more difficult for homeowners to sell. However, if rates fall, this shadow equity decreases, potentially loosening trapped supply and narrowing the bid-ask spread.


In a rising rate environment, home prices might fall as:


1. Homeowners are reluctant to sell, reducing supply.

2. New buyers are priced out due to higher mortgage rates, reducing demand.

3. The bid-ask spread widens, making it harder to find a buyer willing to pay the seller's asking price.


However, the current housing market is illiquid and unaffordable, with conservative lending standards and a supply/demand balance that is not frothy. This could mitigate the potential downside risk of falling home prices.

According to data from the Department of Housing and Urban Development, the median price of a single-family home in the U.S. was $84,300 ($82,800 according to other research) in 1985, which is equivalent to $246,428.64 in today’s dollars.

This means that 39 years ago, $500,000 could purchase nearly six average homes. When adjusted for inflation, $500,000 in 1985 would be worth about $1.46 million today.


$1.46 million (the equivalent of $500,000 in 1985) would be just enough to buy 3.5 homes with an average home price of $419,550 (Q1 & Q2 2024, https://fred.stlouisfed.org/series/MSPUS) . In other words, the home buyer has lost 2.5 houses in purchasing power over the last 39 years.



Source: https://www.visualcapitalist.com/median-house-prices-vs-income-us/, own research, *the data of median house prices vary in range and method of calculation.



Source: https://www.visualcapitalist.com/median-house-prices-vs-income-us/, own research, *the data of median house prices vary in range and method of calculation.


In summary, a dollar in 1985 had about twice the purchasing power for real estate as it does today. If the increase in property taxes is taken into account, the result is even more devastating. Property taxes in the United States have been rising steadily since 1980. While the tax revolts of the 1970s, led by California’s landmark Proposition 13, caused property taxes to level out during that decade, total property taxes paid by Americans were 62 percent higher in 1993, in after-inflation dollars, than they were in 1980. This development has continued thus according to the Tax Policy Center, the effective property tax rate in the U.S. has generally trended upward over the past few decades, though there are fluctuations based on local policy changes and reassessments.



Moreover, the expected rate cuts may not have the desired effect on the housing market. With the current inflationary environment, the Federal Reserve may be hesitant to cut rates aggressively, which could limit the potential boost to the housing market. Additionally, the rate cuts may not be enough to offset the impact of higher interest rates on mortgage affordability.


As we approach the expected rate cuts, we imagine the opposite of the consensus view. Instead of a boost in residential real-estate prices, we see a potential decrease in home prices due to the unintended consequences of rate cuts on the housing market. The decrease in shadow equity and the loosening of trapped supply could lead to a more balanced market, but at the cost of lower home prices.


Furthermore, the rate cuts may also lead to a decrease in the value of the US dollar, which could increase the cost of imported goods and materials, further reducing the affordability of housing.

Additionally, the rate cuts may also lead to an increase in inflation, which could reduce the purchasing power of consumers and further decrease the demand for housing.


This thesis could already be supported by the current median house price, which has dropped to $ 412.300 in Q2 2024, according to the FED St. Louis (https://fred.stlouisfed.org/series/MSPUS).

In conclusion, while the expected rate cuts may provide some relief to the housing market, we believe that the unintended consequences of these cuts could lead to a decrease in home prices – what’s good for a functioning market is not always good for prices.


The decrease in shadow equity, the loosening of trapped supply, and the potential decrease in the value of the US dollar could all contribute to a more balanced market, but at the cost of lower home prices. And we did not even assume a significant loss of jobs …



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