What Happens When Rates REALLY Drop? Probably Not What You Think

Hey friends, it's Dave. Happy holidays and welcome to On The Market. If you nerd out on real estate as much as I do, you probably already know that Logan Motoshami is one of the sharpest housing market analysts out there. When I first started getting into real estate market, housing market analysis, he's one of the main people I started following. I still read everything that he writes and we've had him on the show a couple of times. The last time was back in September to talk about market dynamics at the time and what he expected to see through the end of 2024 and into 2025. And his way of looking at the housing market doesn't just work for a particular moment in time. It really helps you understand the right lens to see the housing market through as we enter a new year. So we're going to bring this conversation back to your feed today. Enjoy. Logan, welcome back to the BiggerPockets podcast. Good to see you again. It's good to be here. Logan, you've been known to come up with some colorful and fun terms for the housing market, like the savagely unhealthy housing market you had deemed it over the last few years. Where we sit today, August of 2024, how would you describe the housing market? You know, we're at the kind of the baby pivot stage of the economic cycle. To be honest, this has probably been the most confusing housing cycle for everyone out there. And, you know, one of the key differences, what we're dealing with now is that the new home sales sector, especially the big publicly traded builders, are able to grow sales. They have the ability to work in a sub 6% mortgage market world, but the existing home sales market still has not been able to be tested yet in a sub 6% mortgage market world. And one of the things I've been trying to do this year, and it's probably to my failing over the last 14 years talking about housing, I don't think people understand how rare it is for nominal home prices to fall going back to 1942. And I think so much of the confusion has been that, well, if home sales crash, prices have to crash because that's what happened in, you know, 2007 to 2011. But the same variables that were very evident back then are not here now. So we're kind of like, you know, in a two guys in a mud fight trying to, you know, grind its way to the who's going to be the winner here. And it's just one of these markets that, you know, it's confusing to people because you would think inventory would skyrocket and prices would fall down. But the housing dynamics shifted after November 9th, 2022. That's kind of been my, one of my calling cards of the last few years. Home sales stopped crashing, but the existing home sales market has been stuck here around 4 million. New home sales are growing. So it's a bifurcated market in that place. And we finally got kind of a baby pivot for the Fed, but we've already had mortgage rates already kind of make almost a 2% move lower from the highs of 2023. So it's now, it's really up to the labor market. If the, if mortgage rates make another significant move lower. And the best way for me to describe this is I try to get people to think about the 1980s. And this is where I realized a lot of people didn't know this. In the 1980s, home sales crashed similar to what we had here. Existing home sales went from 2 million to 4 million, 4 million down to 2 million. Home prices were escalating out of control in the late seventies, even with higher rates. But even in the crash in home sales in the early 1980s, with more inventory, with a recession back then, home prices didn't fall. Affordability was a little bit worse back then than it is right now. So the only thing that changed that was that affordability got better as mortgage rates went 2% plus lower back then. And then because we're working from a very low level of sales, you can get sales to start to increase, but we quite haven't had that sub 6% push in mortgage rates for the existing home sales market to grow sales here. And can you help explain for our audience who may not be as familiar with economics as you, why home sales volume is so important? Because as investors, I think a lot of people get pricing and don't want prices to go down, or maybe they do because they want more affordable housing. But why is the total number of home sales in a given year so critical to the health of the housing market? I would phrase it this way. The existing home sales market went into a recession on June 16, 2022. And when we talk about a housing recession for the existing home sales market, we have to look at it in a different light than the new home sales market. When sales fall, this industry is basically a transfer of commission. So as sales fall, jobs fall, but wages fall, right? So the total activity is, I'm not joking when I say this, this is the third kind of calendar year of the lowest home sales ever, right? Because we have over 336 million people as a population. We have over 162 million people working if I take the non-farm payroll and self-employed. So demand is very low, but also inventory is not that far from all time lows. So if you think about the housing market in this light, most sellers are buyers in this context. 70 to 80% of people who sell their homes typically buy a house. That's the functionality of the housing market. It's a fluid system. We simply collapsed in 2022. We have not been able to bounce because simply the cost of housing is too much. So the transaction models are much different now. Now for the economics, the new home sales sector actually matters more because that's residential construction jobs, apartment construction jobs, remodeling. These things matter because in recent history, we haven't had a job loss recession until residential construction workers lose their jobs because housing gets hit first with higher rates and then it recovers first with lower rates. So the fact that existing home sales are still this low just shows that as a country, we're not selling a lot of homes as an industry. The industry has simply collapsed and not have come back. You see it in the mortgage and real estate industry getting hit the hardest, even in an economic expansion. So that's the relative importance of the housing cycle, but the existing home sale market is much different than the new home sales market. The new home sales market means a little bit more to the economic cycle. For sure, yeah. New construction obviously plays a big role in GDP. I think for our audience, they're probably not as involved in new construction, but obviously want to know what's going on in sort of a macroeconomic level here. It's time for a quick ad break and then we're going to get into the state of housing inventory when we get back. Welcome back to On The Market. Let's jump back in. Logan, through the first half of the year, we were starting to see a little bit of inventory improvement. It was starting to feel like there is a little bit of a loosening going on, but it seems like in the last couple of weeks, that is starting to reverse course. Is that what you're seeing here? Well, I always say when I give my TV interviews, I always say that the best story for 2024 is that inventory has been growing. We did not have a functioning housing cycle with inventory. Our Altos housing wire data that we bring out each weekend, we only had 240,000 single family homes available for sale in March of 2022. Simply for a country this big, too many people are chasing too few homes. We don't believe in the mortgage rate lockdown premise. We believe that higher rates, weakness in demand can increase inventory and that'll be a positive. People have more choices. That's what we saw here. A simple model we use is 70% to 80% of sellers are buyers, inventories are washed, 20% to 30% of inventory is left over. Who buys homes with mortgages? First-time homebuyers. Millennials started buying in 2013. As their mortgage demand grew, inventory started to fall. If the mortgage demand is light, inventory can grow. We've seen this in our slope of our curves in 2022, the middle part of 2023 going on, and this year. Even with all that, we're not back to 2019 inventory levels as a country. There's about eight states that are. 2019 inventory levels were like the five-decade low before 2020. I would say that it is a healthier housing market in the sense that if mortgage rates go down again, we don't have to worry about prices escalating out of control anymore because it's not like we have 240,000 homes and mortgage rates are at 3%. Now, there's parts of the country that are still near all-time lows. I don't consider those places very healthy. Then there's parts of the countries, Texas, Florida, New Orleans, where the cost of housing is actually a little bit more than the other parts of the nation. They also need a little more migration than other states. I'm happier on the economic front because I was not a fan of that, obviously, of that housing market calling it savagely unhealthy. When people have more choices, when rates do fall, then a lot of sellers can actually find something they want and the process is a little bit more normal, much like we saw in the previous decade. Now, it's a little bit more stable. It's a little bit more normal, but the last, I would say, four to five weeks, inventory growth has slowed, price cut percentages have slowed. We're going to see the seasonal peak in inventory soon, and we get to start it all over again in 2025. Just so I make sure I understand and everyone's following this, you're thinking that even if rates come down, that we won't see a huge uptick in appreciation because supply and inventory will rise with demand in a relatively proportionate way? Prices can increase a little bit more, but the fact that we are near 2019 inventory levels as a country means that the supply and demand equilibrium is a little bit more balanced than it was earlier. We broke to all-time lows. We couldn't get any kind of inventory growth unless rates rose. Now, at least, we don't have that same backdrop. If our weekly active inventory was at 300,000, I'd be having a different conversation right now, but the fact that we're at 700,000 on our data lines means that there's more choices out there and rates are still elevated enough to where we're not going to be like a V-shaped recovery in demand like we saw during COVID. As soon as people thought, hey, we're all living, let's go buy houses again, we saw a very sharp comeback in demand. That was with 20 to 30 million people unemployed and 5 million in forbearance. I still get that question today. How did housing demand come back so fast with all those people unemployed? Well, there's 133 million people still working with 3% rates. They're not going to sit there and wait. If mortgage rates go down 2% and stay lower, then it looks like the early 80s, but we don't have to worry about prices taking off like it did during COVID. If rates hadn't gone up in 2022, we were actually trending another 17% to 19% home price growth a year at that point. That's how savagely unhealthy that market was. As a data analyst, I look at home prices escalate like that in a bad way because all that does is it takes the future affordability and makes it harder. Remember, we're all living in a qualified mortgage world these days. After 2010, there's no more exotic loan debt structures. If you're getting a mortgage, you have to qualify for it. The demand is real. It is a very, very funky housing cycle. You really have to follow people that have the live data to try to make sense of it all because I've never seen so many people confused. I've never seen so many terrible YouTube sites talking about major home price crashes. It doesn't work that way. I think one of the things I'm trying to do historically is show people 80 years of data there was one period of time in history going back to 1942 where home prices crashed and the variables that were there were evident in 2005, 6, 7, and 8. The variables are not evident here. There's places of the country where pricing is getting really weak. There's places of the country that have to deal with variables that they're not accustomed to, especially in parts of Florida. But as a general society, Case-Shiller Index just at an all-time high in home prices and that confuses people because they're inundated with fake housing experts who are telling you for year 13 now that home prices are going to crash. There's models for this. There's things that have to happen first. Our job, as always, is to guide people on a weekly basis because we're so much ahead of the Case-Shiller Index and the NAR Home Sales Index that we want to get people ahead of the curve and not have them wait for old, stale data. Logan, before you said that you thought rates would really come down to the labor market, could you explain that to us and how the Fed is thinking about their job of balancing employment with price stability? My premise since the end of 2022 is that the Fed won't pivot until the labor market breaks. A pivot can mean different things to other people, but for rates to actually really go down and stay lower, you're going to need to see labor deterioration. The Fed has their own model for this. They want the Fed funds rate above the growth rate of inflation and stay there until job openings data comes down, quits percentages fall. Part of my highlighting of my work over the last two years is rates aren't going to fall until this labor data line starts to break in. A few months ago was for the first time where I said, okay, we're finally getting to the levels to where the Fed can actually go, we did enough damage to the labor market. Labor market breaking, though, is a different thing. Breaking labor markets means jobless claims start to take off. What's happened is that the growth rate of job creation has finally come down to the levels that I've been looking for after these recent revisions. Again, the bond market always gets ahead of the Fed. The fact that mortgage rates are already here without one rate cut looks pretty normal. Going out in the future, you're going to need to see more labor market deterioration to get that next stage lower. If you look at economic cycles, the bond market and mortgage rates go up and down in a cycle, but then when the recession happens, you get another leg lower. We haven't broken in the labor market yet because the Fed has already told people, we track jobless claims. If jobless claims are near 300,000 right now, we're all having a different discussion, but they're not yet. The big move in rates have already happened. Now, we have to focus on all the economic data even more with a bigger scope because now the Fed has basically said, okay, we cry uncle, labor market has deteriorated enough. We'll cut rates, but we'll keep an eye on it because if it starts to really break, then we'll get more aggressive. Well, if the labor market really breaks, the bond market's not going to wait for the next Fed meeting, 10-year yield goes down, mortgage rates go down with it. One of the beneficial stories of this year, which wasn't the case last year, last year, I thought the mortgage spreads getting to cycle highs, it was very negative for the housing market. Here, the spreads have gotten better just for people who don't know. The spread is the difference between the 10-year yield and 30-year mortgage rate. Historically, going back to the early 1970s, it's like 1.6% to 1.8%. Last year, it got up to over 3%, which is a very high historical level. That meant mortgage rates were higher than what they normally would be, but they're better this year. If the spreads get normal and the 10-year yield goes down a little bit, you're sub 5% mortgage rates. That has worked for the builders. The builders have been able to grow sales in a sub 6% mortgage market. Well, the existing home sales, on the other hand, has not had that luxury one time since mortgage rates got above 6% and stayed above there toward the end of 2022. Thank you for explaining that. I just want to make sure that everyone understands that last thing that you just said about the spreads. Basically, the Fed controls the federal funds rate. They do not control mortgage rates. They do not control bond yields. Mortgage rates are most closely correlated with yields on 10-year US treasuries. There's something called the risk premium between the bond yields and mortgage-backed securities. Usually, it's about 2%, 1.9%. Basically, if you take a 10-year US bond, mortgage rates are going to be roughly 2% above that. For the last couple of years, due to all sorts of factors, inflation risk, some dynamics in the mortgage-backed securities market, that's gone up to 250 basis points. It is creating the scenario where mortgage rates are even higher than bond yields and the federal funds rate would normally have them. What Logan is saying is that there is room for the mortgage rates to come down even without bond yields moving, even without the federal funds rate moving, because the spread can go back to closer to historical rates. I just wanted to make sure everyone followed that. Logan, obviously, you follow this up super closely. Do you have an estimate for where we'll see mortgage rates, let's say by the end of this year, 2024? When I do my forecast, I don't ever really target mortgage rates. I target ranges with the 10-year yield and where mortgage rates should be, because I'm such a nerd that I track this stuff daily and that if something changes, I need to explain why. The forecast for this year was rates should be in a range between 7.25% to 5.75%. I can only go as low as 5.75% with mortgage rates this year or going toward the end. For me to get a little bit more bullish on mortgage rates going lower, I need to see labor market getting softer and the spreads getting better. When the Fed starts its rate cut cycle, and people have to remember this, the Fed will tell you this right now, even if the Fed had cut rates three times, there's still restrictive policy in their minds, because the Fed funds rate is so much higher than the growth rate of inflation. If the Fed starts cutting rates, the spreads get better. If the labor market starts to deteriorate, you can get into that low 5% mortgage market. We're looking at all the labor data to figure out that trigger, but we quite have not gotten to the low level range. I think it's really hard for the 10-year yield, especially people that follow my work, to get below 3.80% unless the labor market starts to deteriorate, we keep on bouncing off that line. Everyone should focus on labor data and Fed talk about the labor data. That would be your key for the next leg move lower, because in a sense, we've already had mortgage rates actually fall almost 2% from the very, very high levels of what we saw in 2023 to the very low levels that we saw recently. We already had that big move, but to get that next move lower, you're going to need to see more economic weakness. You're going to need to see the spreads get better. You're going to need to see the Federal Reserve start to talk more dovish and get there. To me still, they revolve their economic mindset around the labor market. We all see it now. They're talking about it more and more. The growth rate of inflation fell last year already. I always do this paper, rock, scissors, labor market over inflation. That's how we should think about it over the next 16 months. You can get to the low 5%, but you really do need to see the labor market start to get weaker and you need the spreads to get better to get you there, because we've already had this really big move in mortgage rates already. What happens if the labor market doesn't break? Rates are going to stay more elevated than people think until the Fed policy really changes. Now, I would say this, the Fed in their own minds believe that they're still very restrictive. They want to get down to neutral and they're completely fine with getting down to neutral. That might take some time. If the labor market doesn't break, it could take us all the way down to 2026 and rates can slowly start to move lower by the spreads getting better. But if the jobless claims and the labor market data starts to break, the 10-year yield and mortgage rates are going to go faster than the Fed. That's why I always try to get people to focus on the labor market now because I know for real estate, it's different, but everyone can see that mortgage rates really matter now more than any other time in recent history. To get that another leg lower, you're going to need the labor data to get weaker. You need to get the spreads to be better. We've already had such a big move. The history of economic cycles, usually when the market believes the Fed is done hiking rates, you really get a big rally in bond markets and mortgage rates go lower. We kind of already had that. The next stage is really the economic data. You could slowly move down lower if the labor market doesn't break, but there's limits until the Fed really pivots. That's why I try to get people to focus on labor data because it does explain the lower mortgage rates we've had since the start of June. The labor market started getting softer and softer even before the revisions were negative. Watching those negative revisions has been interesting. It definitely makes you wonder how aggressive they're going to be over the next couple of months. We are going to take one last quick break, but as a reminder, we put out news, data, information, just like what you hear on On The Market almost every single day on the BiggerPockets blog. So if you want more of this up-to-date information, check out biggerpockets.com slash blog. We'll be right back. Thanks for sticking with us. We're back with Logan Bodashami. Logan, the last question I have for you is just about affordability because I'm imagining that if rates do come down, the labor market breaks, rates come down, we'll start to see some appreciation. Or if the labor market doesn't break, we'll see rates stay high and prices might still keep growing. So do you see anything that may meaningfully improve affordability in the housing market in the near term? I go back to the early 1980s. You need mortgage rates to go lower 2.5% plus or 2 to 2.5% and stay there. Every economic cycle that we've worked with over the last four or five decades, there's a rate range and then the economy gets weaker and then mortgage rates make a 2% move lower and they stay in there. So the only time I could see where affordability can match today is the early 80s and you had rates go much lower and stay lower and that in itself makes housing more affordable because the cost of debt goes down. And even back then, when people said, oh, it's an affordability crisis, nobody's going to buy homes. When rates finally fell, demand picked up because you're working from a very low level. So you're going to need to see at least rates between 4% to 6% and stay there. And then the longer they stay there, the more people start to plan about their home selling and buying process. It's worked for the builders. The builders have been able to grow sales since 2022 because they actually can work in a sub 6% mortgage rates. That's the only thing I can give. Of course, there's places like, Austin has fallen almost 20% from the peak, but rates are still elevated enough to where it's not in a sense a buyer's market where buyers feel like they're getting a deal. So when rates fall down though, then you get the affordability, then the buyer pool picks up. Like for every 1%, you get a bigger buyer pool. And we always have to remember housing is very seasonal. The purchase application data for the existing home sales market, usually the seasonal heat months are the second week of January to the first week of May. After May, volumes fall. What's happened in the last few years is that we've had this big move lower in rates toward the end of the year. Now, recently, right now, we just had it in summer. So we're kind of past the seasonal time. So there's limits to what you can do even with low rates. I know a lot of people have been saying, well, we thought housing demand would pick up more. Well, it kind of has, but we have to remember, this is a very seasonal sector. So if you've got a mortgage market between 6% to 4% and stay there like it has in previous cycles, like it did in the early 80s, where rates came down from 18, 16, 14, then you could grow sales in that matter. But again, we're only talking about this because we're at record low levels of sales. It's a very low bar. So you could bounce from there. That's the fastest way, because especially in the early 1980s, we did not see home prices fall. And we had a lot more inventory back then. We had a recession. Mortgage rates were higher. And affordability was slightly worse. But here, we just have a lot of home buyers. I will give you guys an estimate here. We're missing about 4.2 to 4.7 million home buyers that would traditionally be here if home prices didn't escalate out of control and mortgage rates didn't. So about 1.3 to 1.7 million per year from 2022, 2023, and 2024. So you have the demographic buyer right there. It's just an affordability thing. And then there's more inventory now than it was the last two years. So there's more choices, but it's really going to take rates. And for that to happen, as of now, still, the labor market has to get softer. Got it. Thank you, Logan. It's super helpful. So basically for affordability to improve, we need to see rates come down a little bit more. For rates to come down a little bit more, we need to see a weaker labor market, more recessionary-type conditions. And we just don't know if and when that might happen. So we're just going to have to be patient and wait and see. Logan, thank you so much for joining us today. We really appreciate it. We will make sure to put all links to Logan's great work on HousingWire in the show notes below. Logan, thanks again. Pleasure to be here. All right. Another big thanks to Logan. As promised, I did just want to briefly summarize some of the main takeaways, at least that I found from the conversation with Logan. Basically, what he says is that the market is a little bit healthier than it had been in parts of 2022 and 2023 because we're seeing a slow but steady increase in inventory. But we're still plagued by low inventory on a historical level and uncertainty on the future of mortgage rates. And because of that, the momentum we saw in inventory throughout 2024 is threatening to slow down as rates start to come back down and more demand comes back into the market. So that's sort of where we are today. But I think we all really want to know what to expect looking forward. And Logan has boldly given us a mortgage forecast, but it's honestly pretty wide. He said high fives to low sevens. Honestly, nothing too revolutionary there. I think that's a pretty broad, well-accepted consensus view. But I did have three main takeaways that I found super valuable from this conversation. First and foremost, one of the questions and things that constantly comes up these days is people say that as soon as rates drop, home appreciation is going to go back through the roof. Logan doesn't think so. Logan doesn't expect housing prices to explode even if rates come down. Because as rates come down, he thinks more sellers will come into the market, and we will maintain in some relative sense some equilibrium between buyers and sellers in the housing market. So that, to me, was the hottest take, most interesting thing to keep in mind, because I think on social media, probably on this podcast, you hear many of us say that when rates come down, home prices will go up. And Logan thinks so, but not maybe by as much as other people are expecting. The second thing is that the depth of rate declines will come down to the labor market, and most specifically, new unemployment claims. We've talked about this a bunch on the show that the Fed has this balancing act to do, and they pay close attention to the labor market. But I love that Logan was basically telling us exactly what the Fed is going to be looking at, because if you want to forecast the market for yourself or stay on top of the trends as closely as possible, keep an eye on those new unemployment claims. The last thing was a little bit disappointing to hear, honestly, when he said that affordability won't improve unless interest rates come down more, and he basically said into the mid fives, and we're still a ways away from that. Because even though rates have come down like 1%, 1.5% from their peak, a lot of that is movement ahead of Fed activity. And as he said, in order to get a quote unquote leg down, which means another significant movement down in mortgage rates, we need to see a much weaker labor market. So it kind of creates this trade off, right? Because most of us want to see improvement to the affordability in the housing market, but that's going to come with a weaker labor market and a weaker overall economic picture, could even be a recession. So you have to remember that mortgage rates don't go down for no reason. Fed usually lowers rates in reaction to adverse economic conditions, and that has its own set of challenges that most people don't want to see. So just a reminder that nothing is perfect. There's never going to be this magical point where rates are perfect, home prices are going up great, and the labor market is perfect. That just doesn't really exist. It's all always in flux, which is why we have this podcast and why we have guests like Logan come on to help us understand what's going on. Thank you all so much for listening. Really appreciate each and every one of you. For BiggerPockets, I'm Dave Meyer. See you next time.