The End of the Long Cold Winter

This week, the Federal Reserve Open Market Committee (FOMC) announced a half percentage point reduction to the benchmark federal funds rate, the first reduction since they started monetary tightening in early 2022. Furthermore, according to the summary of projections, also released with the announcement, the Fed expects to reduce the base rate by an additional half percentage point this year, but even more surprisingly by another full percentage point next year.? In other words, the Fed expects the federal funds rate to be 3.4 percent at the end of 2025, which is a much faster projected trajectory for lower rates than the Fed had projected in June for the end of 2025 (4.1 percent).?

The expectation of a rate reduction had already influenced the market, putting downward pressure on the ten-year Treasury bond yield and by loose association mortgage rates in recent months. Now that the Federal Reserve has started easing and signaled a more aggressive easing trajectory, mortgage rates are likely to fall further later this year and throughout 2025. Additionally, the spread between the 10-year Treasury yield and 30-year, fixed mortgage rate remains significantly wider than usual so there’s room for this spread to narrow, though it’s unlikely to return to historical norms. If the spread narrows, then mortgage rates could come down even more than reduction implied by a lower ten-year Treasury bond might imply.

What does that mean for 2025? While these are projections that may not come to pass, if they do this is unequivocable good news for real estate markets.? How can there not!? Currently, it’s about as low —in terms of existing-home sales volume— as it can go. And affordability has declined dramatically since early 2022 due to the combination of higher mortgage rates increasing mortgage costs and the shortage of supply causing house prices to rise quickly.

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Now, it’s reasonable to expect the 30-year, fixed rate mortgage to be below 6 percent by the end of 2024 (it is already not that far from that threshold) and fall further in 2025, as the Fed continues to ease monetarily throughout the year.? This should cause existing-home sales to rise from their current cycle lows to the constrained mid-4 million (SAAR) range. Sales activity will continue to be constrained by the rate lock-in effect keeping sellers, who would be buyers, on the sideline and limiting inventory. Mortgage refinance activity will certainly increase through the end of 2025 as it becomes less expensive for homeowners to access their record levels of equity whether with home equity loan products or cash-out refinances.

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However, lower mortgage rates might stimulate demand (improved affordability) more than it increases supply (unlock rate locked-in homeowners). Historically, existing-home inventory has made up the majority of total inventory, and most current homeowners with mortgages will still have a mortgage rate below the prevailing rate even as mortgage rates fall in 2025. More demand relative to a continued constrained supply? That could accelerate price appreciation again.

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While we have already been forecasting an increase in commercial real estate (CRE) transaction volume in 2025, that is more assured with monetary loosening lowering the cost of commercial real estate credit. This is important because many potential transactions have not occurred in the last couple of years because the bid-ask spread on buyer and seller valuations for commercial properties has been very wide. CRE transaction volume is likely to be significantly higher than this year or last, and though there will remain pockets of distress remaining to be worked out, most of that will occur over the next 12 to 18 months.

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A long, cold winter descended on the real estate markets when the Fed started increasing rates in early 2022. While the expectation of monetary policy easing has already helped, now that the monetary season has changed, we are at the end of that long winter and hope “springs” for the better days to come in 2025.