Rising Rates Threaten To Complicate 2017 Housing Outlook
Throughout 2016, U.S. housing prices continued to rise by about 5% year-over-year, adding to the cumulative gains made since the lows of 2011. Nationally, home prices now stand above the pre-crisis peak, as measured by the S&P CoreLogic Case-Shiller U.S. National Home Price Index. However, the recent trend toward higher interest rates has raised concerns about the outlook for home prices going into 2017, eliciting a range of responses from sheer panic to resilient optimism.
The post-election interest-rate move has been swift and significant, on a scale and span that mirrors the ‘Taper Tantrum’ of 2013. In that episode, the mere telegraphing by Fed officials that the end of monetary easing was near, amid an uncertain outlook for growth, roiled financial markets across the globe. Equities suffered alongside credit as markets traded lower. As bond spreads moved out, lending conditions tightened in the mortgage market. As a result, existing home sales fell and new home sales stalled.
In this more recent rate rise episode, however, equities have moved higher and credit spreads have narrowed—at least so far. In fact, the total return of the Bank of America Merrill Lynch U.S. High Yield Index was still positive on the quarter through mid-December, despite the fact that rates are now well above the summer’s lows by more than 100 basis points. The key difference this time versus the Taper Tantrum, is today’s very positive growth expectations, driven by the prospects of lower tax rates, lower regulations and increased infrastructure spending.
Higher Rates Lower Affordability
While higher rates have so far had a fairly benign impact on financial markets, they have led to an increase in mortgage rates. Higher mortgage rates can decrease housing affordability, and thus have the potential to lower the demand for home purchases. According to Bankrate.com, the average national rate for a 30-year fixed mortgage was just over 4.15% in mid-December, around 85 basis points higher than the 3.3% lows of September. This means that a home buyer purchasing a new home with 20% down at October’s median home price of $304,500 would now have to pay $1,187 per month at a 4.17% rate, versus $1,070 at a 3.32% rate—an increase of $117 per month.
The rise in mortgage rates comes at a time when many millennials are entering the home market for the first time and may be affected by small changes in affordability. Their impact on overall housing demand is significant, as some 40% of first-time home buyers in 2017 are likely to be within this demographic. Millennials have so far lagged the household formation rates of previous generations. While poor employment prospects in the wake of the financial crisis and the tight mortgage lending environment have been factors, large increases in student debt borrowing may be having a particularly pronounced effect on the rate of household formation for millennials, a topic I’ve written about previously. Add to this dynamic that student debt default rates have climbed in recent years, potentially tainting the pool of future Millennial mortgagees in an environment of tighter mortgage underwriting. Higher interest rates only accentuate these issues, and may further delay millennial home purchases at the margin.
Higher rates can also impact existing home owners looking to move into a new home. These potential home buyers may now face an additional hurdle when considering a move as their existing mortgage rate may be significantly lower than what they would pay on a new home. It is estimated that around 2/3rds of existing mortgages have a rate under 4.5%, and the national average currently stands at 4.13%, which is already lower than today’s rate. If rates rise above the 4.5% threshold, it would imply that the vast majority of those selling their existing home and purchasing a new home will be paying a higher rate on their loan, which may cause home owners to delay or reconsider transactions all together.
Mortgage applications, an indicator of future housing sales volumes, have already declined with rising mortgage rates and were down 4% in the week ending 12/9/16 according to the Mortgage Bankers Association. Meanwhile, the rise in interest rates doesn’t yet appear to be slowing down. In this hostile scenario, implementation of an effective Multifamily Leasing Technology may be of some relief.
Demand Vs Supply
Does this mean housing prices may be about to tumble? Not necessarily. Yes, higher rates will negatively impact the demand for housing, as they already have at the margin. However, the supply-side dynamics of the U.S. housing market remain very supportive of higher home prices.
First, new home construction, though improved from the depths of the crisis, is still considerably below historical levels. In November, single family housing starts grew at an annualized rate of 828 thousand, much lower than the 2006 peak of 1.823 million and the average of 1,022 thousand units since records began in 1959. In fact over the past 40 years, housing starts have only been as low as they currently are during recessions.