Buyers And Higher Rates

With extreme mortgage rate volatility led by the Federal Reserve and geopolitical tensions, it is hard to tell where they will be in the coming months. Real estate prices are often slow to respond to higher mortgage rates. As borrowing costs increase, real estate prices tend to respond according. However, some economists document this phenomenon as real estate inertia. This means that prices are already moving and it will take a long time for higher rates to slow prices and demand. Here is how buyers and higher rates go together.

Federal Reserve Implications

With the expectation of a hawkish Federal Reserve in 2022, we are hearing all kinds of predictions for real estate. Some are predicting that the red-hot U.S. housing market will slow, even on the heels of the record high increases in 2021. In fact, even as rates have increased by close to 1% in 2022, demand has not been affected yet.

The less clear part of the future for real estate is how rising mortgage rates will impact the hot market. If taken at face value, higher mortgage rates should decrease demand and prices. However, the market is slow to respond and takes months for economic aspects to truly show up. Housing looks to be less affordable by the end of the year. This is because higher rates means higher monthly payments, and less potential buyers. With this market fallacy, prices usually decrease respectively.

Buyers And Higher Rates In History

The world of interest rates and home prices correlation is a complicated one. There is a lot of extensive data and many different times in history that we have seen price rises and interest rate volatility. The general consensus is that cutting mortgage rates can often times leads to a housing bubble. However, the precise timing and mechanics of how cutting interest rates plays out is an often misunderstood topic. There is also not much well-established and fool proof information on what happens when the FED and central banks raise rates.

The last time we saw this phenomenon is dating back to the Financial Crisis of 2008. As the Federal Reserve slashed interest rates to stimulate the economy after the tech bubble and 9/11, housing became desirable. Many people conclude that cutting the Federal Funds Rate from 6.6% to 2% is ultimately what led to the housing bubble. Mortgage rates are not controlled by the FED, however, they do follow the rates set by the overnight facilities.

However, there is some science behind this not being the true cause of the housing bubble. According to Robert Shiller, owner of the Shiller Price Indexes, the housing bubble was developing long before low interest rates. In fact, the housing bubble might have started in 1997, when housing was booming and still accelerating while the Federal Reserve was raising rates. Now, this is contradictory to the general rule of thumb that raising interest rates lowers housing demand and prices.

How Buyers And Higher Rates Work

The biggest takeaway from many of the current day economic theories is that housing is not a fluid asset like many others. People tend to believe that housing will instantly be impacted by rising interest rates like stocks and bonds will. However, this is hardly true. Washout in the real estate market takes global issues and happens over the course of months to years. Not days.

Housing, for one, is not like stocks and bonds. It is not as susceptible to fluctuations in rates as other assets are. Housing is one asset that carries very expensive transactional costs. It takes a long time for prices to slow and they hardly respond in weeks to changes in mortgage rates. The economic principle of inertia makes real estate a behemoth of an asset class. Something so large is hard to slow after it starts moving so quickly, and that is the economic principle of inertia. It is an exact copy of the physics principle of inertia, an object in motion stays in motion.

Buyers And Higher Rates Bottom Line

The one thing the Federal Reserve can do to truly impact housing prices is to create a rate shock. This would not only impact housing prices, but ultimately derail the economy and ruin economic outlooks. However, if the Federal Reserve raises interest rates incrementally, housing prices will likely remain resilient. Housing still outperforms traditional investments during high rate environments. It is hard to say how buyers and higher rates will work together, but only time will tell.

Source: Bloomberg