Despite the Federal Reserve’s efforts to curb inflation by raising interest rates, which has helped cool down prices and break the cycle of endless inflation in the US, it has also led to an unfortunate locking effect in the real estate market, increasing various hidden costs for homeowners and potential buyers, creating significant pressure for everyone involved. Many sectors in the US are eagerly awaiting a rate cut to alleviate the situation, but the Fed decided not to lower rates at its June meeting, adding more concerns to the US housing market.
On June 12th, as expected, the Federal Reserve announced maintaining the current interest rate range of 5.25% to 5.50% without a rate cut. However, they plan to lower rates once by the end of the year, instead of the anticipated two rate cuts as most experts had predicted.
On the same day, the Consumer Price Index (CPI) report was also released, showing a continued downward trend in inflation, with an annual CPI increase of 3.3%. Excluding food and energy items, the core inflation rate reached 3.4%. However, it is expected that the Fed has not fully considered the latest inflation data. If the Fed takes into account the recent inflation data, some optimistic experts speculate that the earliest rate cut may occur in September, with a possibility of a second rate cut.
Regardless, the Fed’s announcement of a potential rate cut by the end of the year signifies their belief that inflation is under control. While not committing to two rate cuts, there is a chance of one rate cut this year. This signal to the real estate market indicates a potential decrease in mortgage rates, making the market more liquid and slightly loosening the locking effect caused by high interest rates.
However, some experts, like real estate specialist Jim Parrott and Moody’s Analytics Chief Economist Mark Zandi, strongly disagree with the Fed’s inflation assessment, claiming a “serious misjudgment” regarding housing price estimates, particularly in communities where estimating implicit rental value is difficult. By abandoning this peculiar calculation method, experts believe the inflation rate could reach the 2% target.
In fact, the Fed’s interest rate hikes intended to suppress inflation have paradoxically exacerbated the tight supply situation in the housing market, fueling further price increases and creating several issues:
Firstly, the locking effect of mortgage rates has led to a decrease in home sales. This effect refers to existing homeowners with lower mortgage rates hesitating to sell their homes and purchase a new one due to concerns about acquiring a house under higher mortgage rates.
Recently, the average interest rate for a 30-year fixed-rate mortgage is 7.17%, while the effective loan rate for many outstanding mortgages in the US is only 4.0%. Consequently, people are reluctant to sell their homes and wait for rates to drop significantly before considering a move.
Researchers at the Federal Housing Finance Agency published a report in March on the “locking effect of rising mortgage rates,” estimating that the surge in mortgage rates led to approximately 1.3 million fewer homes sold from the second quarter of 2022 to the fourth quarter of 2023, with California alone witnessing a loss of 182,490 units.
Nearly all of the 50 million active mortgages in the US have fixed rates, mostly lower than prevailing market rates, deterring homeowners from selling. For each percentage point increase in market mortgage rates above the original rate, the probability of a sale decreases by 18.1%.
This resulted in a 57% reduction in home sales in the fourth quarter of 2023, leading to a decline of 1.33 million in home sales from the second quarter of 2022 to the fourth quarter of 2023.
The only ways to break the locking effect are either a compelling need to move, such as due to divorce or bereavement, or an interest rate decrease. However, a substantial rate drop is unlikely in the near term. According to Realtor.com’s chief economist, it could be until the end of the year or even 2025 before breaking the locking effect, requiring a 150 to 200 basis point decrease in the 10-year Treasury yield. Current interest rate differentials suggest that it might take three to four rate cuts by the Fed to alleviate the locking effect, leaving those waiting for lower rates to be disappointed.
Secondly, the perception of the current housing market as unfavorable for buyers is widespread. Recent data from Freddie Mac shows a decline in the Home Purchase Sentiment Index by 2.5 points in May, with only 14% of surveyed individuals considering it a good time to buy, the lowest since the survey began. In contrast, 86% of respondents expressed it was not a good time to buy, an increase from the previous month. Additionally, 64% believe it’s a good time to sell, with a slight decline from the prior month.
These sentiments reflect a pessimistic outlook toward the real estate market, despite homeowners viewing their properties as valuable for sale. However, high interest rates deter homeowners from selling easily.
While the CPI suggests a cooling trend, providing grounds for a rate cut by the Fed, this is still speculative. The current market reflects a lack of purchasing power, exhibiting subdued and despondent sentiment.
Lastly, homeowners are burdened with higher hidden costs than ever before. Holding and maintaining a solo residential property in the US now costs an average of over $18,000 annually, a 26% increase from four years prior. These hidden costs include property taxes, home insurance, maintenance expenses, as well as utilities, internet, cable, and more.
One of the main culprits for rising housing costs is insurance. Over the past years, home insurance premiums have continuously risen, especially in coastal and regions prone to extreme weather events. These factors, coupled with soaring prices, leave some homeowners unable to afford insurance.
Moreover, housing costs vary across regions. California may have high property taxes and energy expenses, while Texas and Florida witness raising insurance rates. In Florida, even homeowner association (HOA) fees have become significant.
In the long run, sustained high costs may limit market liquidity, causing more people to stay in their current homes to avoid higher moving expenses, creating another form of locking effect.
These are the three challenges stemming from the Fed’s continuous rate hikes on the real estate market. While signs of rate cuts are emerging, the speed of rate reduction is expected to be slow. As prices tend to rise easily but fall comparably harder, the likelihood of a housing market resurgence this year is minimal.
Nevertheless, with real estate transactions slowing down and more buyers adopting a wait-and-see approach, the pace of home sales will decelerate, resulting in an increase in housing inventory, unfavorable for sellers.
Redfin CEO Glenn Kelman even predicts a summer price decline, as homeowners waiting for lower mortgage rates understand the urgency of moving. Kelman notes significant price drops in major metropolitan areas in Texas and Florida. In a recent report, Redfin found that over 6% of US home sellers lowered their prices in May, the highest proportion in over a year.
Therefore, eager sellers are becoming impatient with reducing rates, and as market transactions decline, the speed of trade is decreasing. Hence, properties with shortcomings or sellers eager for a quick sale may compromise on pricing to expedite transactions and move on to the next phase of life.
According to real-time Redfin data as of June 9th, despite a 4.4% year-over-year rise in national home prices, sales data present a bleak scenario. Mortgage applications declined by 12%, buyer demand index decreased by 18%, and pending sales dropped by 3.5%, reflecting a continued sales reversal.
With sales slumping, new listings surged by 7.8%, available listings increased by 16.7%, and the proportion of price-reduced properties reached 6.5%, the highest since November 2022. As Kelman suggested, this summer might not favor sellers due to a lack of buyers, possibly leading to a price decrease!
Ultimately, the current real estate landscape is challenging for both buyers and sellers, as the market faces a downturn in transactions and an increase in inventory. The prevailing conditions paint a picture of dry activity, indicating the potential for declining home prices amid a muted market outlook.