August was nerve-wracking for investors.

After the US Federal Reserve left the key interest rate at 5.25 to 5.5 percent at the end of July, where it has been for over a year, investors loudly called for a new one.

The S&P500 plunged 6% in the first three trading days of August as a flood of pessimistic economic data convinced investors that the economy was weakening faster than expected and the Fed had made a mistake by not cutting interest rates.

Stock prices plunged on Monday as a surprise interest rate hike in Japan led to the unwinding of a global “carry trade” in which investors had borrowed low-interest yen to invest in risky assets such as the shares of the Magnificent Seven in the United States.

As a result of the three-day sell-off, economists now expect the Fed to cut interest rates by 50 basis points at its September meeting and by at least another 50 basis points by the end of the year.

The economic situation is likely to remain marked by uncertainty, but one thing is clear: lower interest rates will revive the flagging real estate market and breathe new life into stocks that depend on real estate transactions.

This sector has been hit hard by the housing market slowdown, but a turnaround could be on the horizon. One stock that could soar as the recovery continues is compass (COM -1.84%)the largest real estate brokerage company in the country by revenue.

Image source: Getty Images.

Can Compass get back on track?

Compass went public in the spring of 2021, when the housing market was booming and mortgage rates were around 3%. However, that boom didn’t last long, and as 2022 approached, revenues declined and the stock weakened.

As the real estate market remains on hold, Compass has focused on rebalancing its cost structure, investing in technology and expanding its agent base, which has helped increase revenue even in a difficult market.

Revenue rose 14% to $1.7 billion in the second quarter, and Compass’s principal agent count rose 24% to nearly 17,000 as the company lures new agents with an attractive technology platform and a steady marketing push. After two years of declining total transactions, business is back on a growth trajectory, a sign that the industry is beginning to rebound.

Compass is also targeting positive free cash flow this year and is making progress toward profitability, with adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) increasing to $77.4 million from $30.1 million in the seasonally strong second quarter.

The real estate brokerage industry is in upheaval after a lawsuit against the National Association of Realtors forced brokers to change their business model with more disclosures and information making it clear that the traditional 3% commissions are negotiable. As part of the settlement agreement, Compass agreed to pay $57.5 million.

Compass has also allayed concerns that the settlement would dramatically change the industry. In May, the company noted that in the first few weeks after the settlement, 99% of new listings included offers to pay the buyer’s agent and 96% included commission offers of 2% or more. Compass believes the settlement will have little impact on full-time professional agents.

What lower interest rates would mean for Compass

The real estate market will probably never return to the turbulent levels seen early in the pandemic, when Americans bought second homes in cities and plots of land with gardens in suburbs and mortgage rates fell below three percent.

However, there is significant pent-up demand from homebuyers hoping for interest rates to fall so they can effectively lower their prices through lower monthly payments, and from prospective home sellers who may not want to give up their low mortgage rates with interest rates currently so high.

In June, existing home sales fell to a seasonally adjusted annual rate of 3.89 million, down from a high of 6.6 million in 2021. That represents a 41% decline. Reversing that loss would mean a 70% increase in existing home sales.

Compass doesn’t need that, but even a return to pre-pandemic levels would mean a 50% increase in current home sales, and that should have a significant impact on the bottom line. CEO Robert Reffkin told investors this spring, “We believe falling rates will lead to a massive increase in transactions,” and he predicted that lower rates would mean hundreds of millions in adjusted EBITDA and free cash flow, assuming normalized annual home sales of 5.4 million to 5.6 million homes.

The company is already moving in the right direction; revenues have grown by double digits and growth is expected to accelerate significantly as mortgage rates fall and the real estate market recovers.

Compass stock has already more than doubled since its low point last November, with hopes of a recovery in the housing market and a stabilization of its own business taking center stage. Compass has lost 79% and doesn’t need to recoup those losses to be a winner. The stock could double by recouping just a quarter of those losses.

If the Fed cooperates and the housing market shows signs of life, a doubling of the value of real estate brokerage shares seems quite possible from now on.