by Joe Herrle, CFA
Vice President, Alternative Assets
Recently, a realtor friend of mine shared that transaction volume was notably low due to high interest rates, resulting in a sluggish market. However, with last week’s Federal Reserve’s rates cut, he and likely others in the realty industry are hoping the housing market will be reenergized. While not everyone can buy or sell a house, home ownership is a prominent consideration when creating wealth. And while I’m not in the market to sell my house, I was curious about what is now occurring in the housing market.
When the Fed announced a 50-basis point rate cut last Wednesday, my first thought was to examine the impact on 30-year mortgage rates. As of this writing, the average 30-year fixed mortgage rate has dropped to 6.08%, its lowest level since September 2022. While the current rates far exceed the sub-3% rates we saw in 2020 and 2021, it is still a meaningful decline from the high of 7.79% in October 2023.
The impact of this recent rate cut is already evident in mortgage application data. According to the Mortgage Bankers Association, mortgage applications have surged in September compared to the previous month. Refinancing applications have skyrocketed by 50.3%, while new home purchase applications have increased by 12.4%. This significant surge in activity reassures us that the market is responding positively to the Fed's decision.
My realtor friend should see greater success soon as U.S. housing prices should increase as a reaction to lower rates. We believe home prices are poised to appreciate further for two reasons.
First, a persistent lack of housing supply exists, and higher rates have exacerbated this problem. We are currently experiencing a severe metaphoric “drought” in housing supply, with new home starts having peaked in 2007. Since 2012, new household formations have significantly outpaced new single-family housing starts, and from 2012 to the end of 2023, total new household formations exceeded single-family homes built by approximately 7.2 million units. This substantial gap underscores the magnitude of the supply shortage and why home prices in the U.S. have been up over 50% in the last five years, more than double the increase in wages.
The supply problem has been made worse by higher interest rates. Homebuilders rely on financing to create new homes, and higher rates make it much more expensive to build new projects. Even as rates are beginning to decline, housing supply is notoriously inelastic in the short term; project planning, zoning, permitting and approval times for financing create considerable lags in making new supply available. Alleviating the shortage will take years, even if conditions are perfect for builders.
When it comes to the supply of existing homes for sale, we are witnessing the “lock-in effect,” which occurs when homeowners with low mortgage rates are reluctant to sell their homes and buy new ones at higher rates. While lower rates should increase supply and theoretically diminish home price pressures, the relative increase in demand will dwarf the increase in supply.
Source: National Association of Realtors
Second, lower rates inherently increase demand by making mortgage payments more affordable. The Redfin Homebuyer Demand Index, which tracks home tours and other buying services, has reached its highest level since May 2024, showing a 7% increase from the previous month and a 1% annual increase. This uptick in activity indicates that buyers waiting for the Fed's rate cut are now committing to purchases.
To summarize, the fundamental law of supply and demand reigns supreme in the housing market, as in most markets for real tangible assets. The current imbalance between supply and demand, and the stimulative effect of lower interest rates, create a favorable environment for housing price appreciation.
However, it's important to note that this trend will not be uniform across all regions or price segments. Factors such as local economic conditions, demographic shifts and regulatory environments influence housing markets at a more granular level. As for Portland, home prices may not be a coiled spring due to other factors, but, in the aggregate, the Fed cutting rates should provide a boost to home prices nationally. For these reasons, we remain constructive on housing as a central investment theme in alternative assets and public equities.
Takeaways for the Week
The S&P 500 finished the week up 0.72% and has now hit 42 all-time highs this year
U.S. consumer sentiment continued to rise in late September, according to the University of Michigan’s Consumer Sentiment Index, reaching a five-month high on more optimism about the economy in the wake of the Federal Reserve’s interest rate cut
In data released today, the Fed’s preferred inflation gauge, the core Personal Consumption Expenditures (PCE) index that excludes volatile food and energy prices, clocked in at 2.7% over the prior year during the month of August