How the Fed Slaughtered Real Estate?

Real estate, often considered the barometer of a country’s economy, has experienced major upheavals in recent years. With interest rates soaring dramatically, the real estate market is shaken. This rate hike, engineered by the Federal Reserve, impacted not only new buyers, but also current homeowners, changing market dynamics.

The Fed’s U-turn

Just two and a half years ago, interest rates on a 30-year mortgage reached barely 2.7%. Today they are near systematically 7%. An almost unprecedented change that has brought the gap between mortgage interest rates for new homeowners and existing homeowners to record levels.

In the USA, real estate is usually the sector that is hardest hit by rising interest rates. Most US housing, both new and existing, is owner-occupied single-family housing, where market and construction developments highly dependent on mortgage interest rates.

So when the Federal Reserve began raising interest rates early in the year and 30-year fixed mortgage rates hit their highest level in 20 years, the outlook for the housing sector have become particularly dark.

Throughout the past year, these bleak real estate forecasts have gradually come to fruition. Single-detached housing starts fell nearly 30 % from peaks reached in 2021 and actual private investment in the residential sector fell well below pre-pandemic levels.

Landlords ordered to stay in their homes

New buyers have obviously much more difficult to finance their purchases than before the pandemic. As the monthly costs of buying an equivalently priced home with a 30-year mortgage have increased significantly, this has contributed to push down single-detached housing starts from pandemic highs.

What if rising mortgage rates turn 2021’s low-rate mortgages into golden handcuffs, lock the owners in their current housing? After all, who wants to sell their house if it means give up a 30-year fixed mortgage rate of 3% and be forced to buy another house at rates higher than 7%?

Indeed, home sales in the United States decreased significantly over the past year and are approaching all-time lows since the peak of the real estate market at the start of the pandemic.

The rise in interest rates therefore blocks the current owners by encouraging them not to sell their home. And this problem could persist for years.

Especially since markets don’t expect mortgage rates to return to pre-2022 levels anytime soonwhich implies a long period of depressed housing stocks, the owners postponing the sale in order to keep their debt cheap.

Record property price uncertainty

In a context of high inflation and an explosion in demand for housing due to the pandemic, Americans expected home prices to rise at record speed through mid-2021 and early 2022.

The rise in mortgage rates throughout 2022 has completely changed the situation, bringing expectations back to some of the lowest levels outside of the pandemic shock in 2020. L’house price appreciation slowed in the second half of 2022, but it accelerated again for most of 2023alongside an appreciation of household morale.

More importantly, in the ten years of the Consumer Expectations Survey, people have never been more uncertain about the future trajectory of house prices than at the end of 2021 and the beginning of 2022.

As inflation, recession risk and mortgage rates rose, people were less confident in their own house price forecastsand disagreement about the direction of housing values ​​among the general population was growing.

Uncertainty and fall in real estate supply

This uncertainty, which extends from real estate prices to the general economic environment, est more responsible for the short-term decline in housing supply lock-in effects related to rising mortgage rates.

However, even if consumer uncertainty about house prices is well above pre-pandemic levelsit also decreased significantly compared to to the peaks reached in 2022alongside an improvement in broader house price expectations. That helped bring housing starts and single-detached home sales back to 2019 levels, despite significantly higher mortgage rates.

Furthermore, it is worth remembering that demand often matters more to property investment than direct borrowing costs. And since interest rate hikes have not yet dampened employment and household balance sheets, rising demand is offsetting the massive effects of 7% mortgage rates.

Once again, the housing market freeze is real and well documented. However, if the effects of retention continue to increase, they probably won’t be spread evenly across the country.

The real estate market freeze is an additional burden for housing affordability in the United States, which is already deteriorating. Vacancy rates for homeowners have been falling for years as underconstruction continues the housing shortage, and they just hit a new all-time low last quarter. That’s part of the reason why, despite an overwhelming preference for homeownership, renters under 50 rated their likelihood of ever owning a home at a 10-year low. Americans can thank the Fed.