The Unpredictable Real Estate Market: How Rate Hikes are Impacting Housing Prices

New York
CNN
—

When the Federal Reserve launched its rate hike campaign in March last year, the housing market reacted predictably – mortgage rates rose, which eventually caused house prices to fall.

But after ten rate hikes, the real estate market – traditionally one of the most interest-rate sensitive parts of the economy – is anything but predictable.

“It’s causing a lot of confusion,” said Orphe Divounguy, a senior economist at Zillow.

The Fed has raised interest rates by five percentage points since March last year to help bring down inflation, which is at a 40-year high.

When the Fed raises interest rates, it also increases the interest rate that banks charge each other on overnight loans. Banks and other financial institutions pass the higher cost of borrowing on to consumers by charging them higher interest rates on mortgages, credit cards, car loans, and other loans. In theory, consumers will respond by cutting back on spending, which means businesses can’t raise prices as much as they used to.

Before the Fed announced its first rate hike on March 16, 2022, average 30-year fixed-rate mortgage rates hadn’t risen more than 4% since May 2019, according to data from Freddie Mac. Rates started to rise in anticipation of the Fed’s rate hike decision and climbed even further to 4.42% immediately after the first rate hike. Mortgage rates then continued to rise in tandem with the Fed’s rate hikes, peaking at 7.08% in November, despite four consecutive rate hikes since then.

Mortgage rates have risen lately, after weeks of declines. In the week ended July 6, mortgage rates hit 6.81%, the highest for the year, Freddie Mac reported Thursday.

However, according to data from the National Association of Realtors, the median price for an existing home in May was $396,100, down 3.1% year over year. However, average prices rose 2.6% this month, marking the fourth straight monthly increase. The median price for a new home in May was $416,300. That’s down 7.6% from last May, but up 3.5% on a monthly basis, according to data from the US Census Bureau.

Fed monetary policy is one of many factors affecting mortgage rates, said Charles Dougherty, chief economist at Wells Fargo.

Another important factor is 10-year Treasury bond yields, which tend to be used as an indicator of mortgage rates. But in recent months, the spread between interest rates on 10-year government bonds and 30-year fixed-rate mortgages has widened.

That’s a product of the uncertain economic outlook, Dougherty said. Inflation remains above the Fed’s 2% target, meaning the central bank is likely to implement further rate hikes. But without knowing the full effect that further rate hikes could have on the economy, the Fed could inadvertently trigger a recession, he said.

“Long-term interest rates not only anticipate the Fed’s next move, but also the potential interest rate path over the next decade,” said Len Kiefer, deputy chief economist at Freddie Mac. “Mortgage rates may react to the Fed’s next rate hike, but it may seem counterfactual.”

“For example, if the market concludes that future rate hikes are less likely, that could put downward pressure on mortgage rates. In that case, even if the federal funds rate rises, mortgage rates could fall,” Kiefer told CNN.

In theory, if mortgage rates rise, house prices should fall, as this increases the cost of owning a home and thereby reduces demand. But that doesn’t happen.

That’s partly because higher mortgage rates created a large lock-in effect after the Fed hiked rates, Kiefer said.

At the start of the pandemic, the Fed cut interest rates to near-zero levels in hopes of stimulating the US economy as businesses shut down and workers stayed home to avoid catching or spreading Covid. With interest rates that low, homeowners and homebuyers could then refinance or buy at rates as low as 2%.

That has changed as mortgage rates are now approaching the 7 percent mark. Selling it could mean giving up a low mortgage rate for a potentially double mortgage rate.

“Many existing homeowners have a hard time giving up a sub-4% mortgage and swapping it for a 6% mortgage,” said Kiefer. This has contributed to a decline in the housing stock.

And with many homes still listed above where they were before the pandemic, homeowners have little incentive to sell them.

“It appears supply will be flat for the foreseeable future,” Dougherty said.

The housing stock, i.e. the number of active housing offers, has fallen by a third compared to before the pandemic. In June it was almost 614,000 According to Realtor.com data, as of February 2020, there were nearly 928,000 homes.

In many ways, the housing market is still catching up from the Great Recession, which led to sluggish home construction for nearly a decade, Divounguy said. When mortgages fell below 3% in 2020, homebuilders started to pick up again — though not fast enough to weather the pandemic surge in demand.

Home stocks are likely to fall even further due to “low supply levels coupled with demand for home purchases in the spring,” Zillow’s Divounguy told CNN. In addition, demand for housing remains high because the labor market is still so strong and workers continue to earn more than they did before the pandemic, he added.

“That tells the heart of the story of why the real estate market seems a bit strange right now,” Divounguy said.