Posted on
Dec 3, 2022

Market Update and Analysis: Rate Hikes Harm Affordability and New Construction, Future Shortages Likely.

By
Wolf Rendall and Mason Gatewood

Introduction

The Vontive Data Science team tracks a number of market metrics and has a unique perspective on housing trends. In this blog post, we discuss why increasing interest rates are causing a drop in current demand and how this trend will paradoxically exacerbate the affordable housing shortage going forward. We believe this presents buying opportunities for real estate investors as conditions will improve for first-time homebuyers in 2023 and beyond.

Current State of the Market

The housing market is experiencing its first contraction since 2008’s Great Recession. Demand has cooled in many metros, leading to price decreases and rising supply. This market is starkly different from the one consumers saw throughout 2021 and early 2022. However, the sharp increase in interest rates has offset any affordability gains that would have come from softening prices. While the median home price, according to Redfin, has fallen approximately 9.5% from June’s peak, the average interest rate for a 30-year fixed mortgage has risen nearly 27% in the same period from 5.5% to nearly 7%, drastically increasing monthly payments and pushing affordability out of reach for many households. The recent mortgage rate hikes have come at a breakneck speed since January 2021’s all time low of 2.6%, according to the Federal Reserve.

Today’s Rates Decrease Future Supply

The current state of the market is undoubtedly frustrating for aspiring home buyers, but what are the longer-term impacts of rapid rate increases? Not only have high interest rates curtailed demand, but they are also stifling new construction. Today’s construction permit is tomorrow’s finished home and decreased construction in 2022 and 2023, coupled with improving household incomes, will create another red-hot, high-priced market in 2024 and 2025.

Permits and housing starts in recent months show declines of 19.5% and 21% according to the Census and National Association of Home Builders. Construction is capital intensive and the financing home builders rely on has also become more expensive in our higher-rate environment, leading to decreased production. Construction costs also remain stubbornly high, further affecting home builders' profits. This implies that new homes that would otherwise be hitting the market will not be there when today’s temporary rate conditions abate and demand returns.

Falling Consumer Sentiment and Savings

The University of Michigan’s consumer sentiment survey shows that U.S. homebuyers are the most pessimistic they have been since 1982. High prices and high interest rates are the main drivers of pessimism for both home-buyers and home-sellers, effectively keeping most Americans in place. Vontive’s own real estate investor survey has found that real estate investors and consumers believe that the current market is much worse than the one twelve months ago. Large institutions such as Morgan Stanley are forecasting the Federal Funds Rate to peak this January at 4.5%, declining later in 2023 and into 2024. The effects of decreased construction and household mobility will become apparent when inflation cools, rates decrease, and buyer demand returns to normal levels. We at Vontive see higher interest rates as a temporary suppressant that will exacerbate systemic housing shortages when demand recovers.

Reports show that lack of a down payment and low income are potential buyers’ most cited impediments to purchasing a home. The personal savings rate of U.S. consumers has fallen dramatically since its peak levels in 2021 to 2.3% in October 2022. With a recession widely expected, non-homeowners will find it challenging to save enough money to afford a down payment in the coming years. Programs like VA and FHA loans can mitigate this challenge but other forms of financing typically win out in competitive markets. In short, many have been priced out of purchasing because of high monthly payments and will likely be priced out in the coming years due to an inability to save.

Impact of High Rates on Affordability and Our Projections

Even though home prices are falling, homebuying is still becoming less affordable. Affordability is being constrained by higher monthly payments caused by rising mortgage rates. Rates hit 30-year highs in late October 2022 at 7%. The chart below relies on Redfin’s Median Home Price data and Household Income distributions from the BLS to show that only 35% of households could qualify for the median home at today’s rates, while over 55% could qualify in 2020 and 2021. Assuming a 4% average wage increase in each successive year, and rate forecasts from the Mortgage Bankers Association, we project that nearly 50% of households will qualify by 2024.

Research published by Atom Data sheds further light on the affordability crisis. They state that in Q3 of 2022, the median home price commanded 30% of the average wage, up 5.1% from 24.9% in Q3 2021. Further, a recent Redfin report has shown that a homebuyer in today’s environment must earn at least $107,281 to afford the average monthly payment of a home today, which currently stands at $2,682. This is up 45% from $73,668 last year, even though U.S. wages only grew by 5% in the same period.

Conclusions

We at Vontive project revived market demand in 2023, with a return to normal levels when prevailing rates return to 5% by early 2024. However, systemic challenges to home construction that led to our persistent shortages in previous years are still present and are now compounded by the sharp rise in interest rates. These limits to the future housing supply, which come when we desperately need to build more housing, are likely to induce a shortage severe enough to rival 2021 and a reprise of the appreciation trends of that year.

About the Authors

Wolf Rendall - Wolf is the Director of Data Products at Vontive, Inc. and currently lives in Seattle following 15 years in San Francisco. He has 10 years of industry experience in real estate and financial technology, including Trulia, Auction.com, Ten-X, and SoFi. He obtained a master’s degree in economics from UC Berkeley, leaving a PhD program there in 2012.

Mason Gatewood - Mason is an analyst on the Data Products team at Vontive and is based in Boston. Prior to joining Vontive, he worked as a summer analyst at Capital One in their commercial real estate analytics group. Mason received a B.S. in economics from the University of Pennsylvania’s Wharton School of Business with a concentration in finance.

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