History shows home prices don't respond to rate cuts the way many expect

With the Fed expected to slash interest rates next year, a popular belief is that lower rates will attract more buyers to the housing market and drive up prices.

But is that really true? According to Creditnews Research, the relationship between home prices and interest rates is far more complicated.

Since 1970, there have been eight periods when the Fed substantially cut interest rates. In each of these periods, the real home prices' response has been a mixed bag.

Using the Shiller Real Home Price Index, Creditnews Research determined that rate cuts were associated with rising home values in the late 1980s, early 2000s, and more recently in the early 2020s.

But the same index shows that falling rates coincided with a decline in home prices during the early 1980s, 1990s, and late 2000s.

The biggest decline in home prices over the last 50 years occurred during the 2008-2009 financial crisis when the Fed slashed interest rates to zero.

During that period, the Shiller Real Home Price Index fell from 194 to 148. It would continue falling in the early 2010s when rates remained at record lows.

The 2008-2009 financial crisis may be an outlier, but it shows that home prices are influenced by a variety of factors—not just interest rates.

What interest rates say about the economy

The Urban Institute, a Washington, D.C.-based think tank, reached a similar conclusion as Creditnews Research. The nonprofit organization found a “positive” relationship between higher rates and home prices going back to 1976 but noted only a “weak” correlation between the two.

“[H]igher mortgage rates tend to occur alongside higher home price appreciation, but it is a weak tendency,” researchers Laurie Goodman and Michael Neal wrote.

According to the researchers, higher interest rates “have historically been associated with periods of stronger economic growth, higher inflation, lower unemployment, and stronger wage growth.”

A strong economy typically doesn’t need low interest rates to encourage consumers and businesses to spend money. When times are good, demand for housing also tends to increase.

“When the housing market is strong, typically economic growth is strong,” said Randy Bury, an experienced home builder and land developer with Moderne Communities, an Arizona-based real estate development firm.

The Congressional Research Service (CRS), an arm of U.S. Congress, made a similar observation.

“Increasing home sales are generally viewed as a sign of a strong housing market and a strong economy, as it suggests individuals have both the income to make the purchase and a positive economic outlook,” CRS wrote in a January 2023 report.

Higher home sales mean there are more buyers in the market, which often correlates with rising prices. When demand for housing grows faster than the supply, prices tend to accelerate upward.

The flip side is also true. Home sales (and prices) tend to weaken as demand slows—a feature that’s often observed during recessions.

According to Creditnews Research, real home prices have declined in half of recessions since 1970. This includes the 2008-2009 period and the recessions of the early 1990s and early 1980s.

In the other half of recessions, home prices stayed flat for the most part. The exception is the post-dot-com-crash recession.

When the U.S. economy wasn’t in recession, home prices increased most of the time—as evidenced by the mid-to-late-1970s, the 1990s, 2000s, mid-to-late-2010s, and post-Covid period.

How will home prices respond this time around?

Economists generally agree that the Fed will have to cut rates in 2024 as economic growth weakens.

In its most recent policy meeting, the Fed projected three rate cuts in 2024, amounting to 0.75%. At the same time, it lowered its 2024 GDP growth forecast to 1.4%.

Economists at the Conference Board think the Fed’s GDP estimate is too optimistic. They believe the U.S. economy will grow just 0.9% next year.

Both forecasts are calling for weaker growth than the G20 average of 2.8%.

If the economy does weaken and the Fed lowers interest rates in response, mortgage rates will likely follow. In fact, mortgage expert Matthew Graham recently predicted that 30-year rates could fall below 5% next year.

That’s a significant drop from the October peak of 7.79%.

How will home prices respond to lower rates this time around? Housing experts are optimistic.

“The supply of homes for sale remains scarce [but] Lower mortgage rates may bring some sellers off the sidelines,” said Nancy Vanden Houten, lead economist at Oxford Economics.

“[W]e anticipate the recent fall in borrowing costs and pickup in mortgage activity will translate into a further recovery in sales volumes,” wrote Thomas Ryan, a property economist with Capital Economics.

“In 2024, we anticipate further falls in mortgage rates, which will bring more buyers and sellers into the market,” he said.

But there's one feature of today's market that could potentially offset the effect of more affordable home financing.

Since the onset of Covid, America has been dealing with the biggest housing shortage in history. It's been one of the biggest drivers of home prices.

Jessica Lautz, the vice president of research at the National Association of Realtors, said homebuyers should see a greater supply of homes next year as lower rates encourage more builders to increase construction.

In this environment, Nicole Bachaud, senior economist at Zillow, thinks home prices will be mostly flat in 2024.

“We're expecting home price appreciation to stay flat for the next year nationally, so prices aren't really going to move much from where they're at now,” she said.