Rising interest rates may be a good thing for home prices: Morning Brief

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Tuesday, March 29, 2022

Home prices are soaring and later this morning we will find out by how much, when the latest S&P CoreLogic Case-Shiller national home price index is released.

On top of exorbitant home prices, mortgage rates are on the rise — the 30-year fixed mortgage (most common among homebuyers) topped 4% earlier this month for the first time since 2019 — leading industry experts like Bank of America to say housing affordability “is the worst it’s ever been.”

But higher interest rates may actually be a good thing for home prices and the housing market in general.

“Low rates make housing less affordable in the long run and rates have been on a long downward trend,” wrote Jonathan Miller, CEO of Miller Samuel Inc., a real estate appraisal and consulting firm, in a recent blog post.

The notion is counterintuitive but worth exploring because it’s a valid one. It’s no secret that low interest rates have fueled the overheated housing market. Low rates coupled with depressed inventory levels have been driving up prices — the simple law of supply and demand. Home prices have been increasing every year for a decade now and median sales price is up about 15% in 2021 from a year ago, according to the National Association of Realtors (NAR).

Meanwhile, rates have hovered around historical lows — the rate on the 30-year fixed hit an all time low of 2.83% in October 2020, according to Freddie Mac. With “rates at historic lows you create this demand level that is insatiable,” said Miller, so buyers are “quickly absorbing inventory to the point where it has collapsed.”

Homes are being traded at a rapid clip. Right now it takes a little over one month to absorb all the homes that are for sale in the U.S., according to the NAR. In a “normal” housing market (when supply meets demand) it takes about six months for inventory to be exhausted.

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“House-buying power is more than double it was 20 years ago because interest rates are lower and incomes are 50% higher,” said First American Chief Economist Mark Fleming, noting that about 1% of the total amount of housing stock in the U.S. is currently available for sale — a 50-year low. “Purchasing power will go down because rates go up which should mean less demand.”

As Federal Reserve chief Jerome Powell said during a Senate committee hearing earlier this month, “housing is a very interest-sensitive sector and rates moving back towards more normal levels should act to cool off housing markets.”

The uptick in rates may be starting to do its part to bring demand down a notch. Pending home sales, a leading indicator of the market, fell for a fourth consecutive month in February.

“Higher rates will slow down the velocity of sales and allow inventory to rise, reducing the rampant bidding wars,” said Miller, noting that bidding wars have accounted for half of the transactions in the dozen regions he covers in the U.S.

The tight inventory may be starting to loosen, both the NAR and the CalculatedRisk blog said inventory bottomed in January and at the beginning of March respectively. Not to mention inventory traditionally picks up this time of year — it’s spring, the busiest season for buying a home.

“If inventory were to return to about three-quarters of the pre-COVID level, supply would rise to about four months. That’s still low, but it would be consistent with a meaningful slowdown in the rate of price increases,” said Pantheon Macroeconomics in a recent research note.

Until that happens there is no question that rising rates will put pressure on buyers, especially first-time homebuyers. According to NAR Chief Economist Lawrence Yun, at the current interest rates, monthly mortgage payments for first-time homebuyers have increased 28% from a year ago.

“Higher rates and higher home prices have led to a 30% increase in the cost of housing year-over-year,” Danielle Hale, Realtor.com chief economist, told Yahoo Finance Live yesterday.

Also, Fleming warns about the financial lock-in effect where existing homeowners won’t want to sell to upgrade or move because they would be giving up a mortgage with a 3% rate for one that is at least a percentage point higher. About 80% of inventory comes from turnover of existing homes, not newly built ones.

All that said, there is no doubt “a massive imbalance of supply and demand,” said Miller. So rising rates may be a necessary evil, at least for now.

By Amanda Fung an editor at Yahoo Finance. Follow her at @amandafung

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