What’s Happening with Residential Real Estate?
Despite mortgage rates near all-time highs in decades, residential housing prices have continued to trend higher in the post-pandemic economy. However, these same increased lending rates have caused prices to drop across many areas of commercial real estate. So, why have prices trended so differently in residential real estate?
The main reason higher rates have not negatively affected home prices is what many economists call the “lock-in” effect of low-rate mortgages secured before the steep rise in rates. According to Morgan Stanley's housing strategist Jim Egan, two-thirds of outstanding U.S. mortgages have a rate below 4%. Comparing that to current 30-year mortgage rates of approximately 7%, this rate differential hasn’t been this wide since at least the late 1980’s:
What has also compounded this lock-in effect is that more than 90% of newly issued mortgages in recent years were 30-year fixed-rate mortgages. This has incentivized homeowners to stay in their homes, resulting in very low inventory levels. Considering the basic laws of supply and demand, fewer options available for those seeking a new home have been a primary driver in home value appreciation in the post-pandemic period.
Where do home prices go from here?
Let’s focus on two main factors that can determine future home prices:
Growth Trends: The S&P CoreLogic Case-Shiller U.S. national home price index is up 51% since the end of 2019 (see green box in the chart below). This is well above the index’s long-term historical growth rate for home prices and more closely resembles the above trend growth last seen leading up to the global financial crisis (see blue box in the chart below):
2. Owner’s equivalent rent: This home valuation tool compares non-rented primary residences to how much similar homes cost to rent. According to the labor department, owner-equivalent rent is up 24% since 2019.
Similar to home price appreciation, this four-year rate increase is trending above its longer-term average. However, it is far less than the 114% increase in the monthly payment on a newly purchased and financed home, according to the National Association of Realtors (NAR). Considering the monthly expense of owning and renting as close substitutes, this large gap implies current home prices are overvalued compared to the owner’s equivalent rent.
A reduction in mortgage rates would narrow this gap (decrease the cost of a newly purchased and financed home and bring it more in line with the owner’s equivalent rent). However, this could start to unwind the low rate lock-in effect mentioned earlier and thus increase housing inventory. This would negatively tilt the supply/demand dynamics that have supported housing prices thus far.
It is most important to note that the majority of the extreme risk factors that caused the housing market crash in 2006 are not present in today’s market. This means the probability of a housing downturn to the magnitude of that level is low. However, buying a house now will most likely not produce the wealth effect that it has afforded homeowners over the last decade through price appreciation alone.
Have questions or want to speak with our team directly? Contact us.
Robert Amato, CFP®, CIMA®
Principal
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