The Impact of Rising Interest Rates on the Housing Market | U.S. Bank (2024)

Impact of rising interest rates on housing market

Inflation’s recent resurgence led to the Federal Reserve (Fed) hiking short-term interest rates in an effort to slow the broader economy and lower inflation. Mortgage rates rose quickly in response, leading to increased monthly payments for home buyers.² The combination of mortgage rates exceeding levels not seen in years and home prices rebounding to new highs set the stage for a muddled housing market.

Source: 30-year mortgage rate: Federal Home Loan Mortgage Corporation (Freddie Mac). 10-year Treasury note yield: U.S. Department of the Treasury, Daily Treasury Par Yield Curve Rates. Both as of Nov. 22, 2023.

Home values recover

Home prices, like those for any product or service, are driven in large part by supply and demand. Prior to 2022, supply lagged demand. Home prices skyrocketed through 2020, 2021 and the first half of 2022, particularly in some suburban areas, as homeowners looked for larger houses to accommodate changing lifestyles, including more work-from-home arrangements in the wake of the global pandemic.

According to the S&P CoreLogic Case-Shiller 20-City Composite Home Price Index, home values have fully recovered from a seven-month decline between the end of 2022 and start of 2023.³ By September 2023, average home prices nationwide had rebounded to virtually match highs reached in mid-2022.

Source: S&P Dow Jones Indices.

“Some who track the housing market predicted that average home prices nationally would fall by 10-15%,” says Matt Schoeppner, senior economist at U.S. Bank. Yet at their low point in the current cycle, home prices (based on the Case-Shiller Index) were down only 6.8% before rebounding to previous levels.3 “Even as the Fed tries to slow down housing demand to temper inflation, the result of today’s limited supply of available housing is that we may not see a significant deterioration in home values,” says Schoeppner.

By mid-November, mortgage applications for home purchases recovered from October lows, when applications fell to their lowest levels since 1995. Applications continue to lag, however, and in November 2023 are 20% lower than application activity at the same point a year ago.⁴

Existing home sales have dropped in seven of the last eight months, including a 4.1% decline in October 2023. Over the previous year, existing home sales activity declined 14.6%.⁵

New-home sales are going through a slowdown after picking up in previous months. In October, new single-family home sales fell 5.6% compared to sales activity in September. However, home sales volume in October 2023 exceeded activity from a year earlier by 17.7%.⁶ “Homebuilder sentiment has declined recently,” says Haworth. “It tells us homebuilders are worried that activity may be slowing while costs of construction trend higher.” Haworth also notes that more new homebuyers may be finding better opportunities in the new construction market rather than among existing homes.

The average 30-year mortgage rate in the U.S., which was below 3% less than two years ago, exceeded 7% in mid-August 2023 and peaked at 7.79% in late October.⁷ It’s the highest mortgage rate since November 2000. The result is more costly borrowing, which can dampen housing market activity.

Source: Federal Home Loan Mortgage Corporation (Freddie Mac)

Higher mortgage rates and home prices make affordability a major issue for those trying to enter the housing market. According to the residential real estate brokerage firm Redfin, the median monthly mortgage payment in November 2023 (based on average 30-year mortgage rates and home prices) was $2,616, down slightly from an all-time high of $2,740 in mid-October.⁸ “The combination of higher home prices and elevated mortgage rates creates a meaningful headwind for new homebuyers,” says Haworth. “They either need to be able to make a bigger down payment or they must earmark more of their monthly budget for housing costs.”

Slowing housing activity is likely exacerbated by an inventory shortfall, Haworth says. “U.S. household growth continues, so today’s slower housing market only reflects a relative pause in activity. Ultimately, the environment will improve and more inventory will be required to meet demand.”

Impact on the real estate investment market

For those looking to add diversification by including real estate in their portfolios, a commonly used vehicle is a real estate investment trust (REIT). However, higher interest rates create headwinds for REITs.

“Real estate as an asset class was one of the first to be repriced lower in reaction to higher interest rates,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management. “Although REITs are often considered a way to hedge the risk of higher inflation, the unfavorable interest rate environment resulted in REITs underperforming other parts of the equity market,” Hainlin says. “Improved yields on U.S. Treasury securities create cash flows that look much more attractive in today’s market when compared to REITs.” As a result, demand for REITs has fallen. For the 12-month period ending in October 2023, the S&P Developed REIT Index declined 5.6%, compared to a gain of 10.1% for the S&P 500, a benchmark measure of U.S. stock market performance.⁹

Haworth points out that results vary depending on the category of REIT. “Light industrial properties have generally been the best performing REIT sector,” says Haworth. “There’s still steady demand for apartments, but the market is softer for office properties, and the retail market remains weak, an environment that’s existed since the pandemic began.”

Haworth notes that headwinds may linger for REITs. “Even though REITs are less expensive today than they were in early 2022, there’s not an all-clear signal yet,” he says. “It may take some time to work through the challenges facing this market.”

Housing market’s impact on economic growth

Fed policy has clearly placed housing and other real estate markets on the front lines of efforts to slow the economy's pace and lower inflation. Thus, regardless of the extent of your real estate holdings, it’s important to keep in mind that the housing market can have a significant impact on the broader economy and capital markets generally. “The formation of households is one of the main drivers of economic growth in the U.S.,” says Hainlin. “It has a large spillover effect on the economy, including materials that go into building or remodeling, and furnishings for homes.”

Be sure to consult with your wealth management professional to determine when and how real estate investments might be a good fit for you.

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