Key takeaways
Persistently high mortgage rates continue to dampen housing market activity.
Sales of both existing and new homes are lower than year-ago levels.
Performance of the real estate market is lagging other capital market sectors.
The interest rate environment continues to prove somewhat unwelcoming for many potential housing market participants. 30-year mortgage rates lingered above 7% for much of April and May, but tapered off slightly since.1 High rates continue to temper the willingness of existing homeowners to give up their lower rate mortgage and place their houses on the market. At the same time, high mortgage rates also appear to be dampening new home sales activity. The average U.S. monthly mortgage payment recently reached an all-time high,2 contributing to slower housing market dynamics.
While existing home sales fell less than 1% in May, it continued a downward trend. Existing home sales are down nearly 3% from tepid year-ago levels.3 New home sales failed to pick up the slack. April 2024 new homes sales were 4.7% lower than the prior month, and 7.7% lower than during the same month one year earlier.4
“Mortgage rates are still high enough to hamper affordability,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “There’s just not enough new construction to offset the lack of supply in the existing home market.” Haworth says that potential homebuyers and home sellers who were hoping for a change in 2024’s interest rate environment have been disappointed. “The Federal Reserve (Fed) is holding the line on interest rates for longer than many initially expected, so we’re not seeing much adjustment in the mortgage market.”
Entering 2024, the Fed indicated it was through with what proved to be a significant series of federal funds target interest rate hikes (moving from near 0% to more than 5% in 2022 and 2023). Those rate hikes were implemented with the goal of tempering an inflation spike. Mortgage rates moved up as the Fed bumped the target fed funds rate higher. The Fed projected rate cuts to begin in 2024. However, lingering inflation, still above 3%, has tempered rate cut expectations for now. As a result, 30-year mortgage rates remain close to 7%.1
“From an interest rate perspective, the biggest changes to the housing market landscape have already happened,” says Haworth. “With the Fed apparently done raising rates for now, a degree of uncertainty is removed from the market.” Haworth notes that even if rates don’t trend lower anytime soon, those in the home-buying market at least can anticipate that they won’t see another spike in mortgage rates. “That allows people to better plan as they determine what they need to budget for housing costs.” Yet based on the data, potential homebuyers have not yet found a comfort level with the more costly borrowing environment.
“Housing affordability remains a meaningful problem,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Potential homebuyers are being priced out of the market, or they need to save up more to make a larger down payment to keep their mortgage payment reasonable.”
“Today’s mortgage rates reflect higher yields in the bond market, but also a relatively wide premium spread between 10-year U.S. Treasury notes and mortgage rates,” says Haworth. The spread has recently been nearly twice what it was in early 2022, contributing to more burdensome mortgage rates. “The wider spread between mortgage rates and Treasury rates reflects a lack of buyers for mortgage-backed securities,” says Haworth. The yield spread trended higher in May and June. Haworth notes that the Fed is reducing its own holdings of mortgage-backed securities by $35 billion per month, which might create more pressure on the market and contribute to elevated mortgage rates.
Home prices, like those for any product or service, are driven in large part by supply and demand. After Fed rate hikes began, housing demand dipped and prices followed suit, falling between July 2022 and January 2023. Home values recovered modestly from February through October 2023, when prices in the S&P CoreLogic Case-Shiller 20-City Composite Home Price Index reached new, all-time highs. Home prices as measured by the index then slipped in three consecutive months before recovering again beginning in February 2024, setting new all-time highs in March and April.5
The combination of elevated prices and stubbornly high mortgage rates has dampened housing market activity. For all of 2023, mortgage applications for home purchases fell to their lowest levels since 1995. The challenges remain evident. In mid-June 2024, the unadjusted Purchase Index for mortgage applications was 12% lower than the same week a year earlier.6
Lagging activity is attributed in part of the reluctance of existing homeowners to put their properties on the market, letting go of their low interest rate mortgages and having to take out new, more costly mortgages to buy a different property. This results in a much lower inventory of homes for potential buyers. While 2024 existing home sales are on pace to exceed four million,3 new home sales make up far less of the market. New home sales fell to an adjusted annualized rate of 634,000 in April 2024, down from 693,000 in March.4 “Even with new home sales approaching 700,000 per year, that does not fully make up for the shortfall in existing home inventory,” says Haworth.
The average 30-year mortgage rate in the U.S., which was below 3% until late 2021, peaked at 7.79% in late October 2023.7 That represented the highest mortgage rate since November 2000. Rates declined from October’s peaks, down to 6.60% in February, but then moved back above 7% until recently.7 Mortgage rates appear to fully reflect market expectations that Fed interest rate cuts will remain on hold.
The current environment leads to what may be the highest housing costs of all time. According to the residential real estate brokerage firm Redfin, the median monthly mortgage payment in June 2024 (based on average 30-year mortgage rates and home prices) was $2,781, a modest drop from a recent all-time high. It still represents a 7.8% increase in the median mortgage payment from one year prior.8 “Housing affordability remains a meaningful problem,” says Haworth. “Potential homebuyers are being priced out of the market, or they need to save up more to make a larger down payment to keep their mortgage payment reasonable.” Haworth says this could lead to some belt-tightening by consumers, which may slow activity in other parts of the economy.
For those looking to enhance portfolio diversification by including real estate in their asset mix, a commonly used vehicle is a real estate investment trust (REIT). However, as is the case with the housing market, higher interest rates also create headwinds for REITs.
“Although REITs are often considered a way to hedge the risk of higher inflation, the unfavorable interest rate environment has resulted in REITs underperforming other parts of the equity market,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management. “Improved yields on U.S. Treasury securities create cash flows that look much more attractive in today’s market when compared to REITs.” As a result, demand for REITs has fallen. Year-to-date through June 24, 2024, REITs are again in negative territory, with the Developed REIT index returning -2.09%, compared to a year-to-date total return of 15.01% for the broader S&P 500. Over the 12-months ending June 24, 2024, the S&P 500 gained 27.19% while the Developed REIT index was up just 10.92%.9
Fed policy has clearly placed housing and other real estate markets on the front lines of efforts to slow the economy's pace and lower inflation. Thus, regardless of the extent of your real estate holdings, it’s important to keep in mind that the housing market can have a significant impact on the broader economy and capital markets generally. “The formation of households is one of the main drivers of economic growth in the U.S.,” says Hainlin. “It has a large spillover effect on the economy, including materials that go into building or remodeling, and furnishings for homes.”
Be sure to consult with your wealth management professional to determine when and how real estate investments might be a good fit for you.
Housing prices fell over a seven-month period in 2022 and early 2023 and housing demand dropped when mortgage rates first began to rise. However, housing prices recovered to new record levels in late 2023. After declining in three consecutive months in late 2023 and early 2024, housing prices recovered beginning in February 2024 and reached new all-time highs in March and again in April.5 As a result, homebuyers have to deal with dual challenges of mortgage rates that are much higher than they were several years ago, and rising home prices.
The decision to purchase a home may depend on many factors, including your own personal priorities and financial situation. Some people may require a larger living space or have a desire to settle in a specific community. Those priorities may take precedence over the current mortgage rate environment. While in an ideal world, mortgage rates would be more affordable, each potential homebuyer must determine the right time to purchase a house.
Interest rates began moving up in 2022, and mortgage rates followed suit. Today’s mortgage rates are more than double the rates that existed in 2021.1 That likely means that homebuyers are required to make higher monthly mortgage payments. This caused some potential homebuyers to step back from the housing market. At the same time, it led some current homeowners who potentially were interested in moving to a different house to hold off doing so, and preserve their current, low mortgage rate. Therefore, housing activity has slowed significantly, attributable primarily to the recent change in the interest rate environment.
As interest rates change, learn what the ripple effects across capital markets may mean for investors.
Investing in a real estate investment trust (REIT) is a way to diversify your portfolio. Here's a look at how to invest in REITs and diversify your portfolio into residential and commercial real estate.
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