It’s been quite the year. 2022 started off with a record high market, record low interest rates and and a generally strong economy. That scenario quickly changed when March came around. The US Federal Reserve admitted that inflation was running high, it’s now at 9%, and in an effort to curb it, was going to take a strong stance by raising interest rates. In response, the markets tanked and interest rates for a typical home mortgage now hover around 6.5%.
In terms of what the economy does next, future projections are mixed. On one camp, some people believe that the economy will recover later in 2022 and 2023 and we will rebound thanks to the Federal Reserve increasing interest rates. The other camp believes that inflation will continue to get worse, which will force the Fed to keep increasing interest rates which may cause a downward spiral for the economy. Last week, 8/22, the Federal Reserve announced that they’re going to take a stronger stance in fighting inflation and indicated that they will continue to push interest rates higher. This resulted in the market selling off and the future outlook of the economy getting bleaker.
The big question in everyone’s mind is, what does this mean for housing?
A dance between interest rates in housing prices
Interest rates and housing prices have an interesting relationship with each other. They are inversely correlated. Typically, whenever interest rates go up, housing prices go down and vice versa. The reason for that is because most homes are bought and financed through mortgages. The terms of the financing are dictated by whatever the US interest rate is at the time. When interest rates go up, banks begin to charge more money for the money they lend. Given the typical homebuyer only puts down 20% and borrows the remaining 80% to purchase a home, if interest rates increase even just a few basis points, it drastically increases the monthly mortgage payment for homeowners.
Today we’re in a unique environment. Interest rates have been increasing for the past few months, but we have yet to see a big dip in housing prices. On the contrary, housing prices have instead increased in major urban areas going against conventional wisdom.
Looking at the graphs below, you can see that the median home price across the US continues to increase despite interest rates steadily climbing since January of this year.
Interest rates in 2021–2022:
The combination of interest rates and home prices increasing in tandem have had major negative affects on housing affordability. If we compare rates in 2021 vs. 2022, the delta in cost is extraordinary.
In January 2021, the 30-year mortgage rate was 2.65% and the average new home price in the US was $401,700. Today, the 30-year mortgage rate is 5.65% and the average new home price is now $546,800. Assuming a 20% down payment, that’s a 95% increase in the monthly mortgage payment: from $1,294/ month to $2,525/month.
This seems unsustainable. At some point housing prices need to pull back or interest rates need to come down, otherwise more and more Americans will continue to get priced out of owning a home. Not only that, but interest rates rising have another effect as well.
Rents go up.
Interest rates and rental prices
As we reviewed in the previous section, as interest rates go up, mortgage payments go up as well. This means more and more people get priced out of being able to buy a home. Instead of buying, those people feel financially compelled to rent — which drives up median rent across the board.
In many cities, mortgage payments have now surpassed rents on many homes. This has led to many people preferring to rent instead of own and led to US rents rising 15% year over year in May — surging past a record $2,000/month with asking rents increasing nearly 50% in Austin, Texas, and more than 30% in Cincinnati, Seattle and Nashville.
Unless the supply of apartments and homes increases, those rents will stay elevated and even rise barring some significant economic downturn that causes people to find roommates and live in less space.
This creates the following cycle:
- Homeownership gets more expensive due to increasing interest rates
- Would be homebuyers are priced out of owning and rent instead
- Rental prices get pushed up across the market since those buyers are willing to pay more
- Repeat step 1
A big part of the problem is the housing shortage in the US due to years of under building relative to demand. And there are signs that higher rates are discouraging homebuilders from starting new projects, exactly the opposite of what’s needed to bring down costs. New US home construction dropped in May, with residential home starts declining 14.4% to the lowest number in more than a year.
So whats next?
The future of housing
Hopefully housing prices begin to soften in the coming months as interest rates climb higher. Where it stands now, it’s unsustainable for housing prices to continue to increase while interest rates go up — housing affordability is the lowest it’s ever been in history.
There is some hope though. There’s beginning to be a slowdown in housing sales volume — homes are staying on the market longer than they were previously and prices are just beginning to pullback.
At Homebase, we believe that unless there’s drastic policy change, interest rates will continue to increase and make homeownership more unaffordable, even if housing prices do start to go down. The crux of housing affordability in America is the lack of housing supply necessary to satiate demand across the country. We explored this in more detail in our last blog.
Our goal is to make real estate an investable asset class for everyone, regardless if you have enough money to purchase an entire home or not. By fractionalizing real estate, we give everyone the opportunity to benefit from the continued price appreciation of a historically stable asset class.
Thanks for reading!
Domingo, Homebase Co-founder