The swiftness of the changes in the real estate market are astonishing, yet not unexpected.  I predicted last year mortgage rates would top 5% and they already have come close.  This has led to a 60% drop in refinances and a sharp reduction in sales.  What do these changes mean for real estate prices and in turn the general economy?

What has happened with interest rates?

“Mortgage rates jumped to their highest level in more than three years last week, as investors continue to price in the impact of a more restrictive monetary policy from the Federal Reserve,” said Michael Fratantoni, MBA’s chief economist.  All signals point to continued jump in rates as 10-year treasuries continue their march higher.

Why are refinances so important for the economy?

One profound figure coming out this week is that refinance activity has dropped 60%.  This is not surprising as mortgage rates have gone up over 50%.  Refinance activity in this past cycle has been a huge boost to the economy as owners could pull large sums of equity out of their houses at rock bottom rates.  For example, with housing prices increasing so much an owner could do a cash-out refinance and have enough funds to buy another house/condo.  This cheap liquidity has been the largest driver of the recent housing boom.

As rates rise, housing sales have dropped.

As rates rise, this cheap capital has dried up.  Nationwide due to the surging increases in mortgage rates, the average mortgage is up over 30% and in turn sales are also slowing substantially.  According to the National Association of Realtors Pending Home Sales Index, a forward-looking indicator of home sales based on contract signings, is down 9.5% compared to a year earlier. All four major regions of the U.S. posted annual declines in activity.   Look for this trend to continue as rates continue higher.

How far will sales drop due to rising rates?

Ian Shepherdson, chief economist and founder of research consulting firm Pantheon Macroeconomics, is predicting a dramatic fall in the pace of home sales this year. In a research note, he projected that existing-home sales will drop roughly 25% from the annual pace of 6.02 million set in February to a rate of 4.5 million by the end of summer.

As evidence of this expected slowdown in home sales, Shepherdson pointed to mortgage demand. The most recent data on mortgage applications from the Mortgage Bankers Association shows that the number of applications for loans used to purchase homes is down more than 8% compared to a year ago.

What do rising rates mean for prices?

1. Short term: We are still seeing increases in prices in January and February as inventory remains tight.  Look for these prices to peak shortly and level off substantially after the summer season as rates continue higher.
2. Long term: Long term is a different story.  Rising rates will halt any material future price growth for several years in most markets.  Best case would be flat prices for the next several years, likely is a small decline of around 15% due to increased costs.  In my past blog I discussed in detail that there is really not a shortage of houses, just a mismatch which will enable price declines as the market normalizes.

Is a 2008 remix in the cards?

I don’t foresee a 2008 remix at this juncture as we don’t have the same riskiness of loans leading up to 2008.  This doesn’t mean we are totally out of the woods though.  Americans are highly leveraged with consumer debt hitting a record 15.6 trillion primarily driven by increased mortgage balances and auto debt.   Fortunately the majority of this debt is fixed rate which will soften the blow and hopefully not lead to a “shock” to the economy.  On the flip side, with this much debt locked into low rates there will be a drastic slowdown in real estate along with autos as buyers will not want to give up the ultra low rates which will lead to falling sales and increasing inventory.

Realtors, Mortgage Brokers, Title companies, and Appraisers will be in for a challenging second half of the year as transaction volume slows.  I’m seeing this already as a title order used to take 5 days, now I receive them back in 2-3 days due to the slow down in volume.

Summary:

Although it is unlikely we will see a repeat of 2008, the future will not be smooth sailing.  The markets are foreshadowing a huge downshift for the economy with real estate sales slowing, refinancing plummeting, and rates continuing to rise.  At the same time, this week, we saw for the first time in this cycle the inversion of the yield curve which occurs when shorter term rates (2 year treasuries) exceed longer term rates (10 year treasuries).  This is the most accurate predictor of a recession within the next two years.  An inversion of the yield curve, rising rates, rising inflation, and slowing sales foreshadow a bumpy road ahead for real estate.

Additional Reading/Resources

1. ‘The housing market is in the early stages of a substantial downshift’: Home sales may drop 25% by the end of summer, according to this analyst. Here’s why. – MarketWatch
2. Mortgage refinance demand plunges 60%, as rates hit their highest level since 2018 (cnbc.com)
3. Pending Home Sales Drop for Third Straight Month | Realtor Magazine
4. Consumer debt hits $15.6 trillion in 2021, a record-breaking increase (cnbc.com)
5. Is there really a shortage of houses- Fairview Commercial Lending (fairviewlending.com)

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide.  To get started on a loan all we need is our simple one page application (no upfront fees or other games).

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