Key takeaways
Persistently high mortgage rates continue to dampen housing market activity.
Sales of both existing and new homes are down.
Real estate market performance is lagging other capital market sectors.
Affordability issues continue to trouble the housing market. The cost of borrowing to purchase a home remains high by recent standards. While that factor affects the ability of certain buyers to enter the market, home prices continue to climb as the available inventory of existing homes remains near historic lows. These factors have significantly slowed housing market activity. Housing may be the single area of the economy most affected by the Federal Reserve’s (Fed’s) aggressive interest rate hikes that began in 2022. Now investors wonder whether anticipated Fed rate cuts will alter the housing market landscape.
“Housing affordability remains a meaningful problem,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Potential homebuyers are being priced out of the market, or they need to save up more to make a larger down payment to keep their mortgage payment reasonable.”
“The housing market is at the epicenter of the economic upheaval caused by Fed rate hikes,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. But he notes that economic trends are another contributing factor. “The strong labor market put potential homebuyers in a better position to afford a house, but if we see labor market weakness in the months ahead, that could be another hurdle for the housing market.”
The average 30-year mortgage, which was below 3% less than three years ago, neared 8% in 2023. It remains just under 7% today, little changed from where it stood at 2024’s outset.1
Even though high mortgage rates may be a deterrent to potential new homebuyers, they play a role in reducing supply as well. Many existing homeowners are unwilling to put their houses on the market and sacrifice their lower rate mortgage. The average U.S. monthly mortgage payment recently reached an all-time high,2 contributing to slower housing market dynamics.
Existing home sales slipped to an adjusted annual rate of less than 4 million homes sold. That number is more than 5% below the rate of home sales during June 2023, and fully 11% below the recent peak existing home sales level reached in February.3 New home sales failed to pick up the slack. June 2024 new homes sales were 0.6% lower than the prior month, and 7.4% lower than during the same month one year earlier.4
“Mortgage rates are still high enough to hamper affordability,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “There’s just not enough new construction to offset the lack of supply in the existing home market.” Haworth says that potential homebuyers and home sellers who were hoping for a change in 2024’s interest rate environment have been disappointed. “The Federal Reserve (Fed) held the line on interest rates for longer than many initially expected, so we’re not seeing much adjustment in the mortgage market.”
Entering 2024, the Fed indicated it was through with what proved to be a significant series of federal funds target interest rate hikes (moving from near 0% to more than 5% in 2022 and 2023). Those rate hikes were implemented with the goal of tempering an inflation spike. Mortgage rates moved up as the Fed bumped the target fed funds rate higher. For much of 2024, markets anticipated that Fed rate cuts were on the horizon. Now markets fully anticipate that the Fed will initiate cuts in September 2024.
It isn’t clear how immediately influential Fed rate cuts will be for the home mortgage market. Haworth notes that a positive factor for prospective homebuyers is that even if interest rates don’t trend lower anytime soon, those in the homebuying market can at least anticipate that they won’t likely see another spike in mortgage rates. “That allows people to better plan as they determine what they need to budget for housing costs.” Mortgage rates are more directly tied to trends in 10-year Treasury note yields. Haworth anticipates that any interest rate declines will occur at only a modest pace, limiting the likelihood of rapid improvement in mortgage rates.
“Today’s mortgage rates reflect higher yields in the bond market, but also a relatively wide premium spread between 10-year U.S. Treasury notes and mortgage rates,” says Haworth. The spread has recently been nearly twice what it was in early 2022, contributing to more burdensome mortgage rates. “The wider spread between mortgage rates and Treasury rates reflects a lack of buyers for mortgage-backed securities,” says Haworth. The yield spread trended higher in May and June, then leveled off slightly in July.5 “Mortgage rates could come down if we saw spreads between 30-year mortgage rates and 10-year Treasury yields compress, but right now, there isn’t enough demand for mortgage-backed securities,” says Haworth. One factor contributing to decreased demand is that the Fed is reducing its own holdings of mortgage-backed securities by $35 billion per month.
Home prices, like those for any product or service, are driven in large part by supply and demand. After Fed rate hikes began, housing demand dipped and prices followed suit, falling between July 2022 and January 2023. Home values recovered modestly from February through October 2023, when prices in the S&P CoreLogic Case-Shiller 20-City Composite Home Price Index reached new, all-time highs. Home prices as measured by the index then slipped in three consecutive months before recovering again beginning in February 2024, setting new all-time highs in March, April and May.6
Potential homebuyers appear to be stepping away from the market. For all of 2023, mortgage applications for home purchases fell to their lowest levels since 1995. The challenges remain evident. In late July 2024, the unadjusted Purchase Index for mortgage applications was 15% lower than the same week a year earlier.7
The slowdown in mortgage application activity may reflect the reality facing potential homebuyers hit by a double-whammy of rising prices and elevated mortgage rates. According to the residential real estate brokerage firm Redfin, the median monthly mortgage payment in June 2024 (based on average 30-year mortgage rates and home prices) was $2,671, only slightly lower than the recent all-time high. It still represents a 4.6% increase in the median mortgage payment from one year prior.8 “Housing affordability remains a meaningful problem,” says Haworth. “Potential homebuyers are being priced out of the market, or they need to save up more to make a larger down payment to keep their mortgage payment reasonable.” Haworth says this could lead to some belt-tightening by consumers, which may slow activity in other parts of the economy.
For those looking to enhance portfolio diversification by including real estate in their asset mix, a commonly used vehicle is a real estate investment trust (REIT). However, as is the case with the housing market, higher interest rates also create headwinds for REITs.
“Although REITs are often considered a way to hedge the risk of higher inflation, the unfavorable interest rate environment has resulted in REITs underperforming other parts of the equity market,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management. “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. Year-to-date through July 29, 2024, the S&P Developed REIT index gained 3.55%, compared to a year-to-date total return of 15.44% for the broader S&P 500. Over the 12-months ending July 29, 2024, the S&P 500 gained 21.02% while the Developed REIT index was up just 9.13%.9
Haworth says REIT valuations recently declined to a low enough point to entice more investor interest. “Yet there remain serious challenges in the commercial real estate market, and those are likely to impact REIT values as well.”
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.
Housing prices fell over a seven-month period in 2022 and early 2023 and housing demand dropped when mortgage rates first began to rise. However, housing prices recovered to new record levels in late 2023. After declining in three consecutive months in late 2023 and early 2024, housing prices recovered beginning in February 2024 and reached new all-time highs in March, April and May.5 As a result, homebuyers must deal with dual challenges of mortgage rates that are much higher than they were several years ago, and rising home prices.
The decision to purchase a home may depend on many factors, including your own personal priorities and financial situation. Some people may require a larger living space or have a desire to settle in a specific community. Those priorities may take precedence over the current mortgage rate environment. While in an ideal world, mortgage rates would be more affordable, each potential homebuyer must determine the right time to purchase a house.
Interest rates began moving up in 2022, and mortgage rates followed suit. Today’s mortgage rates are more than double the rates that existed in 2021.1 That likely means that homebuyers are required to make higher monthly mortgage payments. This caused some potential homebuyers to step back from the housing market. At the same time, it led some current homeowners who potentially were interested in moving to a different house to hold off doing so, and preserve their current, low mortgage rate. Therefore, housing activity has slowed significantly, attributable primarily to the recent change in the interest rate environment.
As interest rates change, learn what the ripple effects across capital markets may mean for investors.
Investing in a real estate investment trust (REIT) is a way to diversify your portfolio. Here's a look at how to invest in REITs and diversify your portfolio into residential and commercial real estate.
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