Will Increasing Mortgage Rates Impact Home Prices?

Will Increasing Mortgage Rates Impact Home Prices?

In a world of consistently higher mortgage rates, the U.S. housing industry remains unsteady. Mortgage rates are increasing, which is impacting the number of homes available for sale. It has also reduced the pool of homebuyers that can afford the current mortgage rates. This resulted in 2023 being the slowest year in U.S. home sales since 1995. The good news is that sales of new homes increased in 2023. This shows the demand for housing continues to be strong.

In 2022 and 2023, the Federal Reserve (Fed), raised interest rates on short-term loans. Mortgage rates increased dramatically, changing the market for both homebuyers as well as sellers. Many homeowners are reluctant in selling their homes to take on new mortgages that could be more expensive. This has resulted in a decrease in the number of existing homes available, forcing homebuyers more and more to rely on home construction.

Higher interest rates impact on the housing market

In response to increasing inflation, the Fed changed its monetary policy in March 2022. In a 16-month period, the Fed increased short-term rates 11 times. The Fed's aim was to lower inflation and slow down the economy. In response, mortgage rates soared quickly. This led to higher monthly payments for homebuyers. Mortgage rates were at levels not seen for years, and home prices had risen to new heights. This created unusual housing market conditions.

Mortgage rates today reflect the higher bond yields, but also the wider premium spread between the 10-year U.S. Treasury bills and mortgage rates. Recent spreads have been almost twice as high as they were two years ago. This has contributed to higher mortgage rates. The widening spread between mortgage and Treasury rates is a reflection of fewer buyers of mortgage-backed securities. Mortgage-backed bonds are currently sold at a premium by investors.

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Home values can recover

Supply and demand are largely responsible for home prices, just like any other product or service. Before 2022, home prices soared because supply lagged behind demand. After Fed rate increases began, housing prices and demand both fell between July 2022 to January 2023. According to the S&P CoreLogic CaseShiller 20 City Composite Home Price Index, home values recovered fully from this seven-month drop. In October 2023, the average home price nationwide had reached new all-time heights. However, values fell modestly in November.

Some people who follow the housing market forecast that home prices would drop by 10-20% on average. At their lowest point, the Case-Shiller Index showed that home prices were only down 6.8%.

The existing home sales increased modestly in November after falling in seven out of eight previous months. However, they fell again in the month of December. Existing home sales are still 6.2% below the previous year.

The new-home sales rose 8.0% in December of 2023. New home sales in 2023 increased by 4.2% over 2022. First-time home buyers may have better success in the new construction sector than the existing housing market where the supply is still low. The sentiment of homebuilders turned negative by the end 2023. We hope this doesn't mean a decrease in new home construction because the housing market is still undersupplied and there is a need for more inventory to meet demand.

Mortgage affordability

Mortgage applications for home purchase fell to the lowest level since 1995 in 2023. The total activity of 2023 was 18.7% less than 2022 at the end December. The unadjusted Purchase Index of mortgage applications in late January 2024 was 20% lower than a similar week one year prior.

The average mortgage rate for a 30-year term in the U.S. peaked in October 2023 at 7.79%. This was the highest rate of mortgage since November 2000. This can lead to higher borrowing costs, which can slow down the housing market. Since then, rates have declined but are still much higher than levels before 2022.

Affordability is a major concern for those who are trying to enter the market. According to Redfin Residential Real Estate, based on 30-year average mortgage rates and home price, the median mortgage payment for January 2024 was $2,545, a 7% drop from the all-time-high of $2,735 at mid-October. The higher monthly mortgage costs are still a major burden on those who want to buy a house. Home prices are rising and mortgage rates are also increasing, which is a significant obstacle for first-time homebuyers. Either they need to be able make a larger down payment, or they have to allocate more money to their housing costs.

Will Increasing Mortgage Rates Impact Home Prices?

Impact on real estate investing

Real estate investment trusts (REITs) are a popular vehicle for those who want to diversify their portfolios by adding real estate. However, higher interest rates create headwinds for REITs.

In response to rising interest rates, real estate was among the first asset classes to see its price drop. While REITs can be used to mitigate the risks of inflation, the current unfavorable rate environment has caused REITs to underperform other segments of the equity markets. The improved yields of U.S. Treasury Securities create cash flows which are much more attractive than REITs in the current market. The demand for REITs fell as a result. After spending most of 2023 in the negative, REITs experienced a modest recovery at the end. S&P Developed REIT Index grew by 11.69% in 2023. Despite this rally, REITs trailed the S&P 500's gains of 26.29 %, which is a benchmark for U.S. stock performance. REITs were again struggling in January 2024. The Developed REIT Index fell more than 3%.

REITs as an asset class still present opportunities. The best-performing REIT sectors have been data centers, light industrial properties and cell towers. Demand is still strong. Demand for apartments is also steady. Investors may want to be cautious in areas such as office property.

Influence of the housing market on economic growth

Fed policy clearly places housing and other real-estate markets at the forefront of efforts to slow down the pace of the economy and lower inflation. It's vital to remember that, no matter how much real estate you own, the housing market has a major impact on the economy and the capital markets. In the United States, the formation of households is a major driver of economic growth. The economy is affected by the materials used in building and remodeling homes, as well as furnishings.

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