The gap between median rents and what a new homeowner would pay for a property at today’s mortgage rates has never been wider, at least as far back as we have the data.
That fact will have large implications for the mortgage and housing markets. Since the end of 2019, the consumer price index is up 19%.
Meanwhile, rents have gone up by 31%, from $1,562 to $2,047, while home prices have increased by 41%—from $244,918 to $348,539.
And this doesn’t consider the impact of interest rates, which have increased from 3.74% at the end of 2019 to 7.5% in the latest reading.
This means, assuming a 5% down payment, that the mortgage payments on a mid tier home have jumped from $1,076 to $2,315, an increase of 115%.
Looked at differently, in 2019, most mortgage payments were considerably less than the rental payments; now they are much more. These numbers are oversimplified, as they ignore many costs that homeowners will need to pay. It also ignores local variations.
However, the basic point remains: At today’s high interest rates, owning a home has gotten much more expensive relative to renting. Why would anyone buy a home in this environment? The relationship between local prices and rents may be different than on the national level, and most will still find the stability of owning a home attractive. Mortgage payments don’t go up, and can go down if the borrower refinances.
However, fewer renters will find these arguments as compelling in the face of large increases in their monthly housing costs. This has several implications for the market.
First, most homeowners aren’t experiencing any impact on their monthly payment from this rise in rates, as many either purchased new homes during the pandemic or refinanced their homes under the period of low interest rates.
Approximately 60% of borrowers pay a mortgage rate of less than 4%, and 80% of borrowers pay less than 5%.
Thus, for most homeowners, either renting or buying a new home would represent a large cost increase. Their best bet is simply to stay put. This creates a large “lock-in effect,” limiting homeowners’ mobility.
As rates rose in 2022 and the first half of 2023, the decrease in the supply of homes on the market was offset by a decrease in demand, as fewer renters could qualify for a mortgage.
Mortgage rates rose from the high sixes to the mid sevens over the past four months. But since most homeowners’ rates were below 6% already, this recent increase doesn’t have much impact on the lock-in rate. But it does change the economics for renters. Fewer can qualify for a mortgage.
We would expect that the demand from renters to purchase homes will dampen, even as the supply of homes remains relatively constant. This suggests that, in the short run, we could see some moderation in the home price increases we have experienced over the past few months, or even a modest decline. We would also expect to see houses stay on the market longer and months’ supply continue to increase due to lower demand.
The industry hasn’t yet adjusted to this new environment. Market activity was already much reduced, and with the further increase in rates working its way through the system, the bias will be toward still less market activity.
Existing-home sales are down from a peak of 6.56 million units in October 2020 to 3.96 million units in September 2023, a 40% decline. Meanwhile, the employment of agents and brokers in the real estate industry has actually increased since late 2020.
Similarly, mortgage origination is down from $4.5 trillion in 2021 to an estimated $1.6 trillion in 2023. Meanwhile, employment in the mortgage banking industry is down by 17%. Indeed, employment in these industries hasn’t adjusted to the new levels of activity, and it must do so.
Homeowners will have to reevaluate how they think about home improvements and how to finance them. For years, with the secular decline in interest rates, homeowners would move for more space or a nicer home.
When homeowners have a below-market mortgage rate, they are likely to stay in their home for longer and are more apt to need to make major improvements. But financing is now more expensive. Cash-out refinances require the entire mortgage to be refinanced at the now much higher rate, and home equity lines of credit generally require pristine credit scores.
Second liens, in which the borrower leaves the first mortgage in place and takes out a second mortgage to cover the costs of the renovation, haven’t been a part of the market since the 2008-09 financial crisis.
They will make a comeback. What does all this mean? Fewer renters will seek to become homeowners, decreasing the demand for housing. Supply is already down, as so many borrowers are locked into a low-rate mortgage.
With demand falling and supply constant, the pressure that has raised housing prices and shortened listing times over the past four years will likely ease. It will certainly result in fewer real estate sales and mortgage originations, requiring downsizing of those industries.
It will increase the demand for home renovations, and institutionalize the comeback of the second-lien market. There will be many adjustments ahead.
Source: Barrons