For the past couple of years, the real estate market had been a seller’s paradise, with homes flying off the market, bidding wars, and seemingly insatiable demand. But now, in just a few short weeks, the dynamics have shifted dramatically. Houses that once had buyers queuing up are now languishing on the market without offers. Even previously red-hot markets like Austin, Texas, and Boise, Idaho, are preparing for substantial declines.
The catalyst behind this rapid and unexpected transformation is the surge in mortgage rates, which have reached their highest levels since the 2008 housing crisis. This sudden spike is a response to the Federal Reserve’s recent efforts to combat inflation by raising interest rates. The combination of increasing borrowing costs, coupled with two years of relentless home price appreciation, has pushed many would-be homebuyers beyond their financial limits.
Glenn Kelman, CEO of Redfin, a prominent national real estate brokerage, sums it up: “We’ve reached the point where people just can’t afford a home.”
Housing, more than any other sector of the economy, is acutely sensitive to interest rates. This sensitivity is exacerbated when homes become increasingly unaffordable, as they are now. Therefore, home prices and new construction are central elements of the Federal Reserve’s strategy to combat rapid inflation. The Fed has raised interest rates several times this year to achieve this goal, but this approach carries inherent risks, including the potential to trigger an economic recession if it curtails home purchases and construction activities too aggressively.
While housing may not represent a significant portion of economic output, it has historically played a pivotal role during economic downturns. The housing market operates largely on credit, and new home purchases often lead to additional spending on furniture, appliances, and electronics, which are substantial components of consumer expenditure.
Mark Zandi, Chief Economist at Moody’s Analytics, emphasizes the delicate balance required: “We need the housing market to bend to rein in inflation, but we don’t want it to break because that would mean a recession.”
Currently, home prices remain at record highs, and it may take several months, or longer, for them to adjust—if they do at all. However, this does not obscure the fact that demand has dwindled significantly, and the market has shifted course.
In May, existing home sales fell by 3.4% compared to April, according to the National Association of Realtors, and construction activity is also on the decline. Homebuilders, who were once meticulously managing their inventory through lotteries, are now reducing prices and offering incentives such as discounted kitchen and bathroom upgrades to attract buyers.
Ali Wolf, Chief Economist at Zonda, a housing data and consulting firm, remarks on the stark transformation: “There was this collective belief that housing was invincible—that it was so undersupplied and demand so high that nothing could stop price growth. A very rapid increase in interest rates and home prices has proven that idea to be false.”
This change is significant for a market that experienced a surge following the initial shock of the pandemic. Historically low mortgage rates reduced borrowing costs, while remote work and virtual meetings expanded options for buyers who previously struggled to find homes near their workplaces. As a result, prices soared in previously affordable areas, attracting buyers who had relocated from expensive West Coast cities.
However, after two years of rapid price increases, what were once affordable areas are now out of reach for many. According to Zillow, home values have surged by approximately 40% over the past two years, forcing buyers to stretch their budgets further while running out of viable geographical options.
Add to this the impact of rising mortgage rates, which have nearly doubled this year, and the effects of inflation, which is eroding savings and increasing housing costs. Additionally, a volatile stock market has diminished the value of portfolios that many intended to use for down payments.
Consider the story of Larisa Kiryukhin, who had to leave the San Francisco Bay Area where she had lived for decades due to soaring prices. She and her family moved to Tampa, Florida, hoping to buy a home. However, an extended closing process and subsequent interest rate spikes increased their monthly payment by about $700, causing them to reconsider their purchase. She expressed her frustration, saying, “I moved here just to get a home, and here we go: The prices got so high we can’t afford it.”
The average homebuyer earns around $70,000 per year, according to Moody’s Analytics. A $600-a-month increase in housing costs, roughly the amount added to the standard mortgage payment due to rising interest rates, is beyond the means of most individuals.
Steve Silbar, a real estate agent in Spokane, Washington, has seen a sharp decline in interest among buyers looking for homes priced under $500,000. These buyers typically have limited financial resources, making the recent surge in mortgage rates a significant barrier. “Rising mortgage rates have moved them out of the market,” he observes.
Heather Renz and her husband, clients of Mr. Silbar’s, had their sights set on a $360,000 home. However, recent stock market declines reduced the amount they could withdraw from their portfolio for a down payment, causing them to abandon their plans. She lamented, “We were three-quarters of the way through the process.”
In just a few months, the interest rate on a 30-year fixed-rate mortgage has surged from 3.22% to 5.81%, according to mortgage giant Freddie Mac. While some of this adjustment is attributed to anticipated Fed interest rate hikes, the central bank’s aggressive response to control inflation has played a role. In June alone, the Fed raised rates by three-quarters of a percentage point, marking the largest increase since 1994. Further rate hikes are on the table for July. Any additional surprises could push mortgage rates even higher.
With inflation at its highest rate in 40 years, the Fed has adopted an assertive policy response to rein it in. Higher interest rates can temper demand for significant credit-based purchases, such as homes and cars, as well as business equipment, helping to align supply and demand and curb price increases across the economy.
While home prices remain at record highs, the shifting dynamics in the real estate market underscore the vulnerability of the housing sector to changes in interest rates. Striking the right balance is crucial for the Fed as it seeks to control inflation without pushing the economy into a recession by stifling home purchases and construction activities.
In conclusion, the real estate market, once characterized by soaring prices and fierce competition, is now undergoing a significant transformation. Rising mortgage rates have tested the limits of potential homebuyers and dampened demand in many markets. Although it may take time for home prices to adjust, the winds of change are unmistakable. The evolving real estate landscape presents both challenges and opportunities, and its future trajectory will be closely monitored by buyers, sellers, and policymakers alike.
