Rising Rates, Falling Real Estate — Part 1

What a difference a few months make.  In January, the average 30-year fixed-rate mortgage was just above 3%.  Now – after multiple interest rate hikes by the Federal Reserve – mortgage rates have not just moved up, they’ve more than doubled to 7.3%

 In practical terms that means if you get a 30-year-fixed mortgage to buy a $400,000 home, your monthly payment will now be roughly $1,000 higher than if you bought the same home last January.  Ouch!

 Earlier in the pandemic when mortgage rates were super low and inventory was scarce, intense buying demand pushed home prices up an average of 43%, often in highly competitive bidding wars.  Now, with mortgage rates above 7% and more homes for sale, far fewer people are looking to buy.  In fact, the number of mortgage applications – a direct measure of buyer interest – has plummeted to its lowest level in 22 years.  That’s 22 years, not months.

 This sudden drop has hit new home construction hard, with as many as a half of new construction contracts now cancelled in some areas.  The National Association of Homebuilders’ measure of buyer interest, called the Housing Market Index, is now below 2006 levels.

 In response, many homebuilders have cut prices, and more than half now offer various incentives, such as mortgage buydowns, hoping to attract buyers.  Even some banks and mortgage lenders are advertising rate-adjustment deals after the first year of payments.

 Fewer Buyers Means More Sellers – and Lower Prices

 The number of pre-existing homes for sale in October, compared to the same time last year, shot up more than 30%. That’s a big jump, but still not big enough to entirely offset the very low inventory available during the pandemic.

 Still, a 30% increase in homes for sales nationwide says a lot about where we are likely headed next. While every local real estate market is different, in general, higher mortgage rates mean fewer buyers, fewer buyers mean more homes for sale, and more homes for sale eventually means lower home prices.

 As of the end of August, home prices are down 3% nationwide since they peaked in June.  That doesn’t seem so bad and it may not have happened yet in your neck of the woods.  But if mortgage rates continue to rise, the number of homes for sale will also rise, and real estate values will have no place to go but down.

 Why Would Mortgage Rates Continue to Rise? 

 For the same reason they’ve been climbing all year: the Federal Reserve is trying to cool inflation by raising interest rates.  As of this writing in early November, the Fed has raised rates 6 times this year and promises more to come.

 Rising rates and the threat of more rate hikes ahead has had a chilling effect on the stock market, with the S&P down 21% this year, as of November 9th.  Just as stock market gains make potential real estate buyers more likely buy, stock losses tend to have the opposite effect.

 And, of course, each new rate hike by the Fed, most recently at 0.75% per hike, has indirectly worked to drive mortgage rates higher.  We have to assume that future interest rate hikes will only do more of the same. 

 Even if the Fed quits raising rates – and eventually they will – mortgage rates are unlikely to return to the ultra-low rates of 2020-2021.

 Should I Buy Now, Sell Now, or Wait?

 All real estate is local and all real estate decisions are highly personal, depending on all sorts of individual, family, and investment factors.  (If you would like to discuss your particular situation, please contact us for a no-cost telephone consultation.)

 In addition to important personal considerations, it also makes sense to look at today’s real estate market, not just in this thin slice of time, but in the context of the bigger evolving picture of real estate – past, present, next, and the longer-term future. 

 Each of these four distinct stages calls for a different way to understand the changing real estate market and figure out what to do about it.  This Alert will cover Stage One and Stage Two.  Our next Alert will cover Stage Three and Stage Four.

Stage One (the past): Ultra Low Interest Rates Like Rocket Fuel for Stocks and Real Estate

 Massive money printing by the Federal Reserve since the 2008 Financial Crisis kept interest rates – including mortgage rates – artificially low. Ultra-low interest rates, coupled with the massive government borrowing it allowed, drove the stock and real estate markets up for many years.

 Then during the 2020-2021 Covid Crisis, even more massive money printing, along with enormous government borrowing and spending, boosted stocks and real estate even higher. With mortgage rates at historic lows and pandemic-driven desire for relocation pushing up demand, home prices soared to all-time highs.  Meanwhile, some commercial real estate took a significant hit as the need for retail and office space during the pandemic suddenly tanked.

 With ultra-low mortgage rates and so many eager buyers, home sellers did quite well.  Of course, the downside of selling during that time came after the sale when sellers tried to became buyers, facing low inventory, high prices, and stiff competition.

 Many people who did not sell their homes during the pandemic buying fever may be wondering if now is still a good time to sell.  Depending on your location, maybe.  But unless you own still-red-hot waterfront property in Manhattan or Malibu, you better hurry.  Here’s why…

Stage Two (now): As Interest Rates Rise, Home Prices Cool

 As we’ve repeatedly warned in our books, massive money printing to artificially boost the markets and economy with ultralow interest rates is not risk-free. The significant long-lasting future inflation that we predicted in our books has not yet occurred.  However, due to massive money printing, enormous deficit spending, and supply chain disruptions during the pandemic, current inflation is approaching double digits. 

 In an attempt to control the rising inflation that it helped to create, the Federal Reserve has been relentlessly raising interest rates since the start of the year.  Not surprisingly, rising interest rates have generally spooked the stock market, significantly damaged the bond market, and pushed mortgage rates higher.

 Rising mortgages rates have not impacted all real estate markets equally (or in some areas, at all), but in general, demand from potential buyers has gone from red-hot to lukewarm at best.  If mortgage rates continue to rise and mortgage application numbers don’t quicky rebound from its current 22-year low, it is reasonable to assume few local real estate markets will be permanently spared.  Remember, the stock market has also took a hit this year, largely due to rising interest rates, further reducing potential buyers’ appetite to spend.

 Deciding whether to buy, sell, or hold real estate now and in the future depends on many factors.  (Please contact us if you’d like to discuss).  For those who may considered selling before this year but did not, now might be a good time – before prices fall lower. But if after you sell you need to finance your next home purchase, higher mortgage rates may be unappealing. 

 Some older homeowners are choosing to keep larger homes and rent out spare rooms, rather than downsize.  Meanwhile, young adults are far less likely to buy a home now, with prices still higher than they can afford and rates moving up.  And the demand for commercial real estate continues to wane in some areas.

 So, what’s next?

 Stayed turned for Stage Three and Four in our next Fake Money Real Insight Alert.