Lower Rates, No Longer a Recipe for a Stronger Housing Market

With many central banks around the world initiating – or contemplating – policy stimulus as of late amid a slower growth outlook, coupled with the prospect of further central bank cuts around the globe, interest rates have retreated, and fast. In the U.S., declining yields have translated into reduced financing rates and a nearly three-year low in mortgage rates. 

With cheap mortgage rates, and a still-moderate domestic economy, the U.S. housing market should be poised for a boom – but it isn’t. Given years of elevated price appreciation rapidly outpacing wage growth, many Americans are unable or unwilling to make a home purchase despite low rates. With attention on the prospect of deteriorating domestic conditions and the R-word lurking around the corner (yes, recession!), home sales are slowing.   

While housing is no longer the large net drag on the economy as it once was in the aftermath of the Great Recession, it is far from being the driver of the economy as it was prior to the financial crisis.  With the Fed poised to cut rates again, potentially as soon as September, an additional rate cut could help boost business investment and confidence, however, there is little hope an additional quarter point reduction in rates from an already historically low starting point will do anything more to prop up the American housing market.

Lower Mortgage Rates, but Lower Sales

With central banks around the world cutting rates and the Federal Reserve lowering its target for the first time in ten years last month, global yields and other financing rates have retreated. In fact, mortgage rates, in particular, have dropped to the cheapest level in nearly three years. Last week, according to the Mortgage Bankers Association, the 30-year fixed rate mortgage fell below 4%, the lowest level since November 2016. But, as mortgages are cheaper than they have been in years, Americans’ appetite for big ticket home purchases is dwindling. 

Existing home sales rose 2.5% from 5.29m to a 5.42m unit pace at the start of Q3, as expected, according to Bloomberg, and following a 1.3% decline the month prior. In the details, single family sales rose 2.8% after a 1.1% decline in July, while multi-family sales were flat. Year-over-year, existing home sales rose a minimal 0.6% in July, following nearly a year and a half of negative sales growth. 

New home sales, meanwhile, unexpectedly dropped 12.8% from 728k to a 635k unit pace in July, a two-month low. According to Bloomberg, new home sales were expected to rise 0.2% at the start of Q3. Year-over-year, sales rose 4.3% following a 17.8% rise the month prior. With a fall in the pace of sales, the months’ supply of new homes rose from 5.5 to 6.4 months, a two-month high.

Month-to-month volatility aside, Americans are still buying homes – particularly new construction – but the boost from lower rates isn’t much of a boost at all. After all, rates have already been historically low for years. Furthermore, as Bloomberg News reports, a cheap mortgage is great, but a cheap house is better. And at this point, even with a 3.69% mortgage rate, a more than 70bp reduction from this time last year, homes are still nominally expensive.

A Cheap Mortgage is Good, A Cheap Home is Better

Over the past few years, U.S. home prices have grown at an impressive rate. At an annual pace of 5%, 6%, 7%, home prices were trending more than 2 or 3 times the average wage growth since 2013. By early 2018, however, prices reached a precipitous and consumers appeared unable or unwilling to make a home purchase at such elevated levels, and prices slowed dramatically. 

In May, the S&P Case-Shiller 20 City Home Price Index rose 0.1% and just 2.4% over the past 12 months, the slowest pace since August 2012 and the 14th consecutive month of waning momentum from a peak of near 7% in March 2018.    

While home price appreciation has finally cooled back down in line with earnings, after years of elevated growth, a home purchase still remains a distant prospect for many Americans. For example, an average American with a 5% savings rate of gross income per year and a median salary of $60,000 would have to save nearly 30 years to afford a median priced home in many U.S. cities. In some major cities such as San Francisco, Los Angeles, and Honolulu, it would take even longer, more than 40 years!

Typically, when buyers are priced out of the market and pushed to the sidelines, nominal housing prices fall as a result of insufficient demand. But many industry insiders suggest the lack of inventory or undersupply of housing in today’s market has trumped hesitant buyers, keeping prices elevated. In July, inventories were largely unchanged, while newly-listed properties fell 7% year-over-year. Furthermore, inventory at the lower-priced end of the market – for first-time and entry-level buyers – has been declining for some time. At the start of the third quarter, the number of homes priced below $200,000 fell nearly 10% year-over-year. 

Aside from being unable to afford a home purchase, many Americans, particularly younger generations, are simply unwilling to purchase homes. Historically, first-time buyers have accounted for a significant portion of market activity, roughly 40-50%. More recently, however, the number of younger buyers searching for their first home has dropped significantly to only 30% of sales. There is a corresponding 15% increase in the number of adult children reportedly living at home with their parents, and more than 50% suggest they would simply prefer to rent as opposed to buying a home. Among the primary reasons dissuading them from making a home purchase, 1) affordability and 2) too much existing debt, including student loan debt. 

Housing Boost

After four years of raising rates and six months on the sideline, the Federal Reserve cut interest rates for the first time in ten years along with a number of other countries, providing additional stimulus to prop up the world’s major economies. Coupled with the prospect of further central bank cuts around the globe, interest rates have retreated. Prompted by fears of slowing global growth and the risk of contagion on the domestic outlook at least the silver lining of expected further rate cuts from global central banks is easy – easier – credit conditions. 

While the U.S. economy is far from booming, a steady state coupled with lower financing rates should be a recipe for robust housing activity, instead, activity is slowing. Despite a substantial decline in mortgage rates, specifically, with home prices still at relatively elevated levels, a lack of inventory coupled with growing concerns of a global recession, home buyers remain sidelined. 

Lower loan rates could give the market a short-term boost and fuel refis, at least on the margin, but the longer-term challenge for the U.S. housing market comes from a lack of desirable supply and dwindling affordability. Buyers are eager to take advantage of lower rates but in many cases, sellers are hesitant to even list properties as the economy begins to slow and home prices cool. 

-Lindsey Piegza, Ph.D., Chief Economist