The housing market is feeling the pressure of higher rates. The signs are everywhere. Higher mortgage rates, lower sales of existing homes, fewer houses being listed, a reduction in mortgage applications, home prices, and residential investing, everything points to a remarkable slowing down of the housing market in 2022.
The Federal Reserve started raising rates in March of this year. The last four FOMC meetings have delivered 75-basis-point hikes, taking the federal funds rate from 0-0.25% in March to 3.75%-4% in November. Where can we see the effects?
The goal, in the simplest terms, is to reduce inflation without hurting economic activity, especially employment. The most recent CPI data showed inflation receding to 7.7% in the last twelve months, a positive sign, although not near enough to declare the job done.
At the same time, the labor market has remained in good shape, with low unemployment—3.7%, near the all-time low—and good job-creation numbers—261,000 non-farm jobs created in October. It is in the labor market where most analysts are looking for signs that increased rates are indeed slowing down the economy. A rise in unemployment, which is yet to come (but we believe it will), is widely considered as the main factor that could trigger a pivot from the Fed, either putting a stop to interest-rate increases or forcing the central bank to reduce them. The median projection from FOMC members for unemployment in the next two years is 4.4%, although we believe it is likely that a higher level will prevail if inflation is indeed brought down to the 2% target level.
As for economic growth, the U.S economy grew at an annual rate of 2.6% during the third quarter of this year, casting aside fears that the U.S. is already in recession (GDP had declined during the first two quarters, nevertheless).
The housing market is under pressure
However, higher rates have had a significant effect on the housing market. The housing market matters because it is one of the main sources of wealth for people. Akin to stocks, when prices go down, homeowners are less wealthy, and thus less prone to spend (wealth effect). Less spending contributes to bring down inflation. It is also relevant, of course, as an important source of economic activity and employment (accounting for 15%-18% of GDP, according to the National Association of Home Builders).
The effects on the housing market should not be surprising, of course. Most homebuyers need loans to purchase homes, and the rates of those loans have shot up spectacularly in the last few months. The average rate for a 30-year, fixed-rate mortgage was 6.90% on the week ending on November 11th, according to Bankrate the week before, it sat at 7.29%, whereas it was close to 3% at the beginning of 2022.
Freddie Mac’s Primary Mortgage Markets Survey shows a similar picture: 30-year mortgage rates topped 7% on average in the last week of October, the highest level in 20 years. This is nearly four percentage points higher than the average rate one year ago.
When fewer people buy homes, the construction and home-furnishing industries are also directly hurt, helping to slow down the economy, and thus contributing to reduce inflation. The downside is the effect on employment, which the Fed would like not to be too large.
Right now, the housing market is slowing down at one of the fastest paces on record. Sales of existing homes fell by 24% in September from the previous year, marking the eighth consecutive month of decline, according to data released in October by the National Association of Realtors (NAR). We had not witnessed such a long downturn since 2007. The number of listings also fell in September by 22% year-over-year, reaching 503,156 units.
Regarding mortgage applications, data collected by the Mortgage Bankers Association show they are down 38% this year compared to last, which leaves them at their lowest level since 1997. Regarding prices, figures released by Redfin revealed that 22% of homes for sale reduced their prices in September, a new record.
Looking at the S&P CoreLogic Case-Shiller Home Price Index, prices were 13% higher in August compared to the same month last year. However, in July that number showed an annual gain of 15.6%. That 2.6% reduction in just one month is the largest ever recorded by the index since its inception in 1987. This constitutes a clear sign of the rapid deceleration of the housing market. Moreover, that record had, in turn, been shattered in July, as well.
One would expect these changes to seep into the rental market, and that has indeed been the case. The price of rent is going up fast, with single-family home in the United States being 11.4% more costly to rent in August year-over-year, according to CoreLogic. The rate of change has decelerated for four consecutive months, however, yet rents are 26% higher compared to pre-pandemic levels, which translates into an extra $400 per month needed to cover rent. At the same time, rental demand in the third quarter fell to its lowest level since 2009, according to RealPage. This may point to many people being priced out of the market.
Support for this conclusion was also provided by a UBS survey released in September, which showed that 18% of adults in the United States had lived rent-free with a friend or family member over the past six months. The number stood at 11% at the same time last year, and the current share is the largest since data began to be collected in 2015.
In terms of investing, residential investment fell at an annual rate of approximately 26% in the third quarter, according to the Commerce Department. As stated above, existing home sales fell in September, and new homes did not fare better: they were down 11% from the previous month. To this, we have to add contract cancellations, which the National Association of Homebuilders says have more than doubled compared with last year. Demand in October is unlikely to increase, given that demand for mortgages is at its lowest in a quarter of a century (see above).
The housing market is slowing down fast in 2022. Fewer people are able to buy homes, and prices are decreasing, reducing the wealth of homeowners. However, we do not see signs of a crash in prices in the horizon. In fact, the National Association of Realtors recently reported that the median existing-home price for existing homes (all housing types) in September was $384,800, 8.4% higher than a year before.
A major factor for this is tight supply: the number of homes currently offered in the market is small compared to 2008 and 2009: approximately 1.25 million in September versus more than 4 million, according to the National Association of Realtors. Moreover, total housing inventory in September was down 2.3% from August. What’s more, the wave of foreclosures contributed to boost supply back in 2008 and 2009. Nowadays, many homeowners have secured fixed-rate mortgages at low rates, which leaves them less exposed to risk and, crucially, less willing to move, as their new rates would be much higher.
The Freddie Mac (Federal Home Loan Mortgage Corporation) is a government-sponsored enterprise (GSE) which buys mortgages and sells them as mortgage-backed securities (MBS) to private investors.
The S&P CoreLogic Case-Shiller Home Price Index measures the U.S residential real estate prices.
The FOMC (Federal Open Market Committee) is the monetary policymaking body of the Federal Reserve System.
The CPI (Consumer Price Index) measures the prices of a representative basket of consumer goods and services. Every month, the CPI is reported by the U.S Bureau of Labor Statistics.
The GDP (Gross Domestic Product) is a measure of the value of all the economic output of a given country or region.
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