As mortgages soar, should we expect house prices to crash?
As the United States flirts with recession, one of the big losers in the recent series of US interest rate hikes has been the housing market. What does the data suggest?
First of all, it’s certainly not that bad, yet. Today, house prices remain high, year-over-year, Zillow recorded an 18% rise in house prices in July. A little more pessimistic, Redfin’s
But it’s getting worse. Other housing data suggests impending trouble. For example, the S&P Select Homebuilders Index has underperformed the S&P 500 by 11% since the start of the year, and the performance of building materials stocks has been similarly poor. The stock market is a reasonable predictor of future earnings, but it doesn’t always get it right.
This implies that there are problems with the housing market. Only a handful of equity sectors performed worse, such as media, textiles and auto parts. However, many factors are fueling homebuilder profits. So is there a problem with the homebuilders themselves or with the housing market in general?
Soaring mortgage rates
Rising mortgage costs are a concern for the housing market as a whole. Mortgage costs have risen very quickly. Today, a 30-year variable rate mortgage bears an interest rate of 5.5%. Last year it was less than 3%. That’s a dramatic increase in mortgage costs. It’s a move that, like recent inflation data, we haven’t seen since the 1980s.
It is fair to expect rapid increases in mortgage costs to cool the housing market. For many, the constraint when buying a home is not the listed price of the home, but their ability to pay the mortgage. Rising mortgage rates can lower home prices than many can afford.
Other Constraints on US Consumers
While mortgage costs are critically important, it should also be noted that the resumption of student loan repayments next January (even with some debt relief) and potential recession risks in the US could also damage consumer confidence in home purchases. So there are also other negative omens.
Supply and demand
Then the image of the offer deteriorates a bit. According to supply data from Redfin, there are now more homes for sale and it is taking longer to sell them. This creates an overhang in the housing market. We are not at crisis levels. Supply is just back to 2020 levels, and selling time is similar to the worst of 2021. However, this during the summer period which is traditionally very strong for housing, so things are definitely going in the wrong direction and the next few months could well be worse.
Of course, the Fed is probably not done raising rates yet. Another rate hike is expected at the Fed’s September meeting. However, the good news is that mortgage rates generally price in what the markets think the Fed will do in the future. This means that longer-term mortgage rates should only rise if the Fed raises rates more than expected, and could actually fall if they raise rates, but less than the market thinks. However, there is still a risk that in 2023, if the Fed continues to raise rates, mortgage rates could rise further, as markets do not know which direction the Fed will head in 2023.
So the stock market is worried about housing, and that may be partly because mortgage rates have risen very quickly. We are starting to see homes take longer to sell and more homes are available. This suggests that real estate prices could start to decline after a strong advance.
However, it’s also worth checking that we’re just starting to see house prices come down and they’re still going up year-on-year. Also, house prices tend to be fairly stable. An extremely bad housing market, historically speaking, where prices fall around 10% like in the 1970s or during the financial crisis of 2008-9. Thus, compared to the stock market, the negative fluctuations in house prices are quite small.
House prices have been on the rise lately. There are plenty of good reasons why this may start to moderate. Although history reminds us that home prices in the United States tend to be quite stable. That 1980s era when mortgages soared like they do today? Well, house prices only saw a quarter of the price declines in this entire decade, and that was less than 1%.
So yes, real estate prices might no longer increase in double digits. In fact, there are many signs that things will get worse in housing. However, remember that what’s really bad for the housing market rarely equates to a single-digit drop in house prices, if history is any guide.