Interest Rates: Experts Weigh in on When the Fed Might Move the Needle

What does the future hold for interest rates? Many real estate developers, consumers and economists are weighing that question as mortgage interest rates hover at roughly seven percent, more than double what they were during the height of the pandemic.

Tax Credit Advisor spoke with economists and developers to understand what recent data might indicate and whether it could move the Federal Reserve (Fed) to lower the federal funds rate. We also spoke to developers on how today’s interest rate environment impacts deals.

Hovering around seven percent, mortgage rates are certainly higher than in recent years, but still much lower than the double-digit interest rates of the 1970s and 1980s. Still, the higher rates make development deals more difficult to pencil out and have significantly slowed the housing market in general.

And uncertainty around rates creates uncertainty in the housing market, which in some ways can be more difficult to deal with than higher rates, some developers say.

“What we see from developers is as long as they see stability, and it’s not moving all over the place, they can figure it out,” says Marshall Phillips, principal at CohnReznick.

Rate Cuts in 2024, 2025 or 2026?
Several economists who spoke with Tax Credit Advisor say they see lower rates on the horizon, but that horizon may be farther out than many people had predicted a few months ago.

Rob Dietz, senior vice president and chief economist with the National Association of Home Builders, explains that the Fed has a set target for bringing inflation down to two percent before it will lower rates. Inflation is still running in the three percent range.

The Fed measures inflation using the Core Personal Consumption Expenditures (PCE). Core PCE measures inflation by quantifying changes in goods and services but does not include the price of food or energy due to their volatility. The Consumer Price Index (CPI) includes food and energy. Both measures include housing in their calculations.

“The current Core PCE in the first quarter was around 2.9 percent. The Fed’s target is two percent,” explains Dietz.

Dietz says he does not see the PCE getting to two percent until 2026.

“But it doesn’t have to be two percent for the Fed to ease,” he says. “It can be on a path to two percent…and we think that begins in December of this year. Many data show the Fed will begin to ease at the end of the year and going into 2025.

“We think by the end of 2025 the typical 30-year, fixed-rate [loan] will be right at or right under six percent,” he adds. “The series of rate cuts could reduce long-term interest rates by about 100 basis points.”

Dietz says one of the components of the index that needs to go down is the cost of housing.

“What is needed to bring shelter inflation down is more housing,” he says. “The challenge is the cost of financing is elevated in terms of construction and development and it’s holding back housing supply.”

Analysts at Fannie Mae revised their rate cut forecast in June, stating they expect a rate cut by the Fed later this year.

“We updated our forecast that it would likely only be one cut this year and that will be in December,” says Mark Palim, vice president and deputy chief economist at Fannie Mae.

Palim says inflation and employment are the top two data points, among others, that the Fed is eyeing.

Palim adds that moves by the Fed could lower mortgage rates to 6.8 percent in 2024 and 6.5 percent in 2025.

“If the economy holds up and mortgage rates moderate to the mid six’s that would be good for the housing market,” he says.

Lindsey Piegza, PhD, chief economist and managing director at Stifel Nicolaus & Co., stresses that consumer spending also is a key indicator of an economy’s health, and the U.S. consumer is still out there spending. The labor market is also still very strong.

“The Fed is really focusing on the health of the labor market and by extension, the broader health of the consumer,” she says.

April and May showed some, but minimal improvement in terms of inflation easing.

“But the Fed will need more data to ease the policy rate back to neutral,” she says. “We think there is going to be enough slowing for the Fed to cut rates in the first half of next year. But, with less than half the year left, I don’t think there is enough time and data to convince the Fed that a 2024 rate cut is appropriate.

“We will see rate cuts eventually, but eventually appears to be a 2025 event.”

Impact on the Housing Market
The higher interest rates and uncertainty on when or how the Fed might act significantly impact the housing market, experts say. And some measures of the economy’s health have not yet shown up in the data, says Caitlin Sugrue Walter, vice president of research at the National Multifamily Housing Council.

“All over the country we are seeing slowed rent growth, and it is not showing up in the CPI because of how they measure rent,” Sugrue Walter explains, adding that one way researchers measure rent is to ask homeowners what they would rent their homes for, which is highly inaccurate. Actual lower rent prices take time to appear in the calculations.

“When you have rents that are declining and borrowing costs continuing to go up, it makes deals difficult to pencil out,” she explains.

Sugrue Walter says a lack of clarity on when the Fed might start easing is impacting real estate costs and deals.

“If you think there may be cuts looming, you are not going to do anything until those cuts come,” she says. “If we could have some clarity on what could go on (with rates) it could help the market.”

Phillips, of CohnReznick, says he believes the rate environment is more settled than it was a year ago.

“When we were in the rising rate environment a year ago, that is when we saw things slow down,” he explains. “Now, things have settled down, and developers are figuring it out.”

Higher rates often translate to higher rents, says Lawrence “Larry” Curtis, president and managing partner with WinnDevelopment.

“Every one percent movement in rates necessitates about six percent more rent to support the same capital,” says Curtis. “When long-term financing rates move from four to seven percent, as they have in recent years, it means the same deal would need 18 percent higher rent to support it or, with rents kept flat, about 30 percent less supportable debt requiring more gap filling subsidy.”

Curtis adds that in many ways, speculation about future rates does not help close deals in the present.

“If rates come down a year from now or two years from now, that does not affect the deal that needs to close today,” Curtis says. “If rates do come down, we are still locked into long-term financing once we close. It may make the next set of deals somewhat easier to do, though.”

Still, despite the current seven percent mortgage rate environment, deals get done, as they did decades ago when rates were in or near the double digits, Curtis adds.

“For years and years, we did development deals when long-term rates were nine and ten percent,” says Curtis.

Phillips adds that it is also important to remember the higher rate environment’s impact on the families who live in affordable housing communities and all communities.

“The cost of living is certainly impacting everyone right now. Rent is only a portion of (families’) costs to live,” he explains. “The higher interest rates force more tough choices on a family on an income level where they are already making tough choices.”