Broker Check

Market Update: State of Housing

August 16, 2023

Monitoring the real estate market and interest rate hikes has left me wondering why prices are still so high?! Monthly mortgage payments have nearly doubled; for example, let’s look at a $400k mortgage. Prior to the rate hikes a family could borrow $400k for 30 years and only pay $1600 per month and $180K in interest over the life of the loan. With rates where they are today that same mortgage would cost $2,600 a month and result in almost $550K in interest paid over the life of the loan. You would think this nearly 64% increase in monthly housing costs would put pressure on the housing market to cut prices so they remain affordable to buyers, but so far they are not budging.

Let’s dive into why that is….

1. House Prices.

Housing appreciated during the pandemic because of a surplus of cheap money from the government stimulus and record-low borrowing costs. In 2020 and 2021 housing appreciated 11% and 18% respectively, bolstering homeowners' balance sheets. These increases sent demand to the moon for homes as the herd saw an opportunity to “get rich quick.” Additionally, at the time, the Cap Rate (term used for the rate of return on investment properties) was around 7 - 8% or higher. This meant that anyone who bought a rental house could see double-digit growth and 8% income on their investment at a time when savings accounts were only paying 0.01% and bonds were paying below 1% in income. This appreciation has already started to cool thanks to recent rate hikes. Housing is expected to flatline in 2023 with home values going down 0.2% according to estimates by Freddie Mac. This is a good sign as the rate hikes are effectively cooling the market and inflation. 

2. Housing Supply. 

62% of US mortgage holders have a rate below 4% and 92% have a rate below 6%. The recent sharp increase in rates has left existing homeowners in a conundrum. They can either trade their $1600 per month payment for a $3000 payment or stay put until rates come back down. Most are electing to stay put which limits the supply of homes available on the market. This disincentive to sell is why the number of homes sold hit a record low this year. In our opinion, this is the key reason housing has stayed level so far.

What do we expect to happen next…?

There are a few factors at play, but the longer interest rates remain high the more painful it will be for real estate investors. This is because of opportunity costs and uncertainty. As rates on bonds and other income-bearing investments have come up, we have seen many dollars flee into these investments. We live in a time when you can make a 5% yield on a property while also having to manage the asset and take on the risk of something happening to it, ie…it needs a new roof, A/C unit, natural disasters like wildfires or tornadoes…etc. Or, you can make 5% or more just sitting at home doing nothing. This value proposition should help cool demand for real estate which allows for the supply issues we discussed earlier to level out.

New housing starts are hitting new highs! The constraints put on building supply chains during the pandemic have subsided and new construction is on fire. New starts on Multifamily structures with 5+ units hit all-time highs this year as young families demand more townhomes. New starts across the board are at their highest levels in many years. This should also help with the supply issues and eventually bring prices down.

Considering all this data we believe that IF rates remain high, prices will come down, but that is a big IF. The Fed has already hinted that they may start cutting rates as soon as next year which would reignite demand for housing from many (like me) who have been waiting on the sidelines. There is a meaningful probability that these rate cuts may take longer than expected. Inflation went up in July 2023 after a precipitous drop all the way to 3% through June. This is a step further away from The Fed's goal of 2% which brings us a little further from lower interest rates.

Looking Forward -

IF inflation & interest rates remain stubborn it may not be a good time to purchase real estate with borrowed money. Cash transactions are still viable and in the long run real estate is still a great addition to any portfolio. That is why each of our clients maintains some exposure to the real estate industry in their portfolio.

That being said, if you have any questions about the real estate market or your investment portfolio in general please reach out to us for a free review.

Schedule A Call With Us!