Rising interest rates typically go hand in hand with steep declines in housing prices. But as Columbia Business School's Christopher J. Mayer watches residential values remain stubbornly strong in much of the United States this season, he sees it as evidence of a new dynamic at play.
Mayer, the Paul Milstein Professor of Real Estate in the Finance Division at CBS, has been researching the cycle of housing bubbles and busts for at least three decades. But today's situation is highly unusual. The difference, he says, is the combination of two unique factors: a strong labor market and a population of homeowners that, thanks to the last refinancing wave, have low interest rates on their mortgages.
Because of those dynamics, the inventory of homes for sale remains near historic lows. Potential sellers are not pressured into selling due to job loss, so they're choosing to remain in their homes rather than taking on a new mortgage when the interest rate could be double what they are paying today. And because restrictions on excess supply have made it a seller's market, sales prices have remained high. All together, these factors have created an unusually stable housing market. And while we're seeing higher interest rates dampening demand among some higher priced homes — and in overpriced markets like San Francisco and Seattle — Mayer predicts that overall, the market will remain steady unless unemployment spikes or rates keep rising beyond expectations.
Interest Rate Pressures
A new interest rate environment has been putting pressure on housing since the Federal Reserve Board began raising the federal funds interest rate about a year ago. The Fed's attempt to fight inflation resulted in 10 consecutive rate hikes, with a quarter-point increase in May reaching 5.25 percent, with more rate hikes likely coming in the future. Mortgage rates jumped rapidly as well, topping a high of 7 percent at the end of October 2022, according to Mayer. Rates stabilized moderately at the beginning of April, but even with the slight decline, mortgage rates remain well above what most borrowers could have locked in during the prior year.
Signs of the cooling effect from higher interest rates are evident in a decline in overall home sales. In 2022, annual existing home sales fell 16 percent and annual new home sales dropped 17 percent, reaching pre-COVID-19 levels, according to the National Association of Realtors.
Typically, in a climate like this, home prices would have fallen across the United States, Mayer says. While home prices have softened in some parts of the country from their peak levels in 2022 — dipping 7 to 14 percent in key metropolitan areas across the West and Southwest — nationally, they fell only 3.7 percent by May. And home prices have started rising again across most of the country, according to data from the S&P CoreLogic Case-Shiller Index.
“In normal downturns, you'll see credit deteriorate, people end up underwater on their houses, and then home prices fall a lot,” Mayer says. “But we don't see that right now — it's an incredibly unusual market.”
Mayer credits a tight supply with bolstering prices. And he anticipates many homeowners will continue to stay put, given the substantially higher cost of buying a home for most current homeowners who might otherwise move.
“We're coming off a period where interest rates are rising rapidly, and that means a lot of people are living in homes where they have 2.5 percent or 3 percent mortgage rates,” Mayer says. The math of moving just doesn't make sense for would-be sellers who would swap these low interest rates for a much higher rate, he adds.
Mayer contrasts today's market with what typically would have happened when interest rates more than doubled. “Based on the sharp run-up in rates, you might have expected home prices to fall significantly, by 10 percent to 20 percent,” Mayer says.
Emerging Risks
So far, Mayer has noticed one exception to this steady market: jumbo loans. The collapse of Silicon Valley Bank earlier this year along with challenges in the private label securitization markets has caused contractions in the market for loans that are too large for traditional 30-year mortgages. “If you're buying a $1.5 million home, it's harder to borrow money and rates are near their 2022 high,” Mayer says. “Banks seem less willing to lend, and if you look at the top of the market, there will be relatively more challenges.”
In the nine months leading up to April, traditional 30-year mortgage rates and jumbo mortgage rates were similar. But by the first week of July, an appreciable gap in rates developed: Jumbo rates reached 7.17 percent while 30-year conforming rates were 6.81 percent, reversing a trend for most of last year, when jumbo rates were lower than traditional mortgages. Mayer also anticipates banks may cut back on some home equity lines of credit.
“Jumbo mortgages are not only seeing higher rates [but] banks may have tougher credit standards,” Mayer says. “Someone who could have gotten a loan last year is going to have more paperwork and more scrutiny.”
The Job Market Holds Steady
Overall, Mayer doesn't see jumbo loans as a harbinger for struggles in the real estate market. Instead, he's watching unemployment and interest rates. Despite some notable layoffs, the job market remains strong, which is supporting higher real estate prices, he says. Mayer's prior research examined sellers' loss aversion and the natural reluctance to lose money on a real estate transaction. His findings showed when given a choice, most people will postpone a sale rather than realize a loss.
“The vast majority of American homeowners have no reason to sell,” Mayer says. “Employment is very strong, and people don't even have to move for jobs because so much of work is remote. If they need more space, they may choose to make an addition instead.”
However, Mayer is watching some differences emerge in markets where prices ran up the most, boosted by increased demand during the height of the pandemic. Those markets could deteriorate further if job losses accelerate or rates keep rising, he says.
“If the Fed gets its way and the labor market really does soften, then we may go back to seeing signs of distress,” Mayer says. “But as of now, it doesn't look anything like what we have seen in past housing downturns like 2008.”
Watch CBS Professor Stijn Van Nieuwerburgh discuss his research into how the COVID-19 pandemic and a sharp shift toward remote and hybrid work has impacted commercial real estate:
