Navigating Trade and Housing: Lessons from McKinley's Era to Modern Markets

At-a-Glance: Key Takeaways on Real Estate Investing & Market Dynamics

• Long-term Implications Uncertain – Recent tariffs echo historical trade strategies, with implications pending future agreements.
• Residential Market Impact – Certain pockets of the residential markets are experiencing challenging conditions. 
• Untethering Housing Markets – Key areas that could be in focus to untether the markets including normalizing mortgage spreads, addressing residential broker compensation, and reforming capital gains tax.

Within President McKinley: Architect of the American Century, renowned author Robert W. Merry covers the rise of President William McKinley—including his early stance as a stern “protectionist” and association with tariffs implemented in the 1890’s. Interestingly, Merry also covered McKinley’s impactful time in the White House, including his pivot to “reciprocal tariffs”, a key factor in igniting a two-decade period of falling tariff rates globally, as well as “solid prosperity” and “expanding foreign trade” in the U.S. 

While such developments transpired more than a century ago, the outcome is worth contemplating in conjunction with the recent tariff announcements and reflex pronouncements that they will be long-lasting. Nevertheless, it will likely be months (if not quarters) before more definitive trade agreements are in shape to evaluate, let alone extrapolate the long-term implications thereof.

In our experience though, “macro” events such as these can often drive opportunities and outcomes at the “micro” level. Therefore, we continue to monitor such trade-related developments, assess their potential impact, and contemplate what other areas could be in focus following any sort of resolution on trade. 

To that matter, many signs point to U.S. housing. Why is that the case? Well, for starters certain pockets of the residential markets are experiencing very challenging conditions. For instance, the “new home market” has remained steady for the past few years, while the “existing home market” is in a rut with home sales activity in 2024 reported at the lowest level in 30 years (and more than a half century when viewed on a per capita basis). At the same time, residential investment has historically contributed about 4% of total Gross Domestic Product (“GDP”). However, when viewed alongside ancillary activities, the residential real estate markets are estimated to account for nearly 20% of GDP by some measures, with the recent slump acting as a drag on economic growth.

As a result, it is not inconceivable to expect some of the structural issues impeding housing turnover to be addressed—especially as an offset to the anticipated reduction in federal employment and government spending. With that being the case, there seem to be three areas that could be in focus to untether the markets, including: 

• Normalizing Mortgage Spreads: At the end of the quarter, the spread between the cost of a 30-year fixed-rate mortgage and the yield on a 10-year U.S. Treasury Note was approximately 2.6%. While this spread has narrowed since the record levels of bond volatility experienced in 2022, it still sits nearly 1.0% above the long-term average, thus costing borrowers almost 10% more per month, by our estimates.
• Addressing Broker Compensation: The traditional model for residential broker commissions (i.e., 6% of the sales prices, split 50-50 between buyer and seller brokers) was upended through a 2023 court ruling. As a result, the National Association of Realtors (“NAR”) was forced to move away from requiring commissions to be included in listings, while giving the buyer the right to negotiate the fee directly. While seemingly a “win” for the consumer, the remedies have led to significant distortions and loopholes, creating more ambiguity in the marketplace.
• Reforming Capital Gains Tax: One of the more-recognized factors limiting existing home sales has been the “lock in effect”, with approximately three-quarters of borrowers sitting on mortgage rates below 5.0%. That said, one of the more often overlooked impediments to moving is the capital gains tax that can be incurred at the time of the sale. While there is an exemption for primary residences (i.e., $250k for single-filers), these amounts have not been updated since 1997 and can lead to meaningful transactions costs given house price appreciation (“HPA”) trends since then.
  

We acknowledge there is no “silver bullet” for addressing these issues. However, it is not implausible to expect the spread for 30-Year mortgage rates to narrow through a combination of (i) the Federal Reserve reducing its pace of selling Mortgage-Backed Securities (MBS) and (ii) lifting outdated stipulations on Fannie Mae and Freddie Mac to allow these well-capitalized entities to foster additional liquidity in the marketplace while also returning to “risk-based” pricing. Further, it seems as if the Department of Justice (“DOJ”) could bring more clarity to residential brokerage practices, while the exemption for capital gains tax could be remedied in a reconciliatory tax bill. 

Such changes are certainly not our “base case expectations” per se, but their probabilities seem higher than most narratives would suggest in our view. They also represent potential “macro” changes that could have implications at the “micro” level—as well as important ramifications for companies throughout the residential value chain.