Will the Fed’s Rate Hikes Break the Housing Boom?
“Bubble Watch” explores trends that may indicate upcoming economic and / or housing market problems.
Buzz: It’s a safe bet that the appreciation in house prices will subside after the Federal Reserve admitted to underestimating the inflationary impact of its cheap money policies in the pandemic era and will start to take measures that will drive up interest rates in 2022.
Source: My Faithful Spreadsheet looked at 33 years of mortgage rate statistics from Freddie Mac and the impact of rising financing costs on the median selling price of all homes in the six-county area of California from South, as tracked by DQNews.
It’s time to take a refresher course on what can happen to local housing when mortgages get more expensive. It is not always a disaster for house prices.
Looking at all 12-month periods since 1988, southern California home prices have appreciated at an average annual rate of 5.4%. Yes, it is not always on the rise as prices have fallen in 23% of the 12 month periods.
But increases in mortgage rates – when they increased over a 12-month period – have happened 32% of the time.
Please note that when rates increased, prices had increased by an average of 8% over the previous 12 months. Rates generally rise in times of economic strength. And growing demand generally raises the prices of goods, services and money.
Consider November’s results for the region: a record median price of $ 693,500 after gaining 15.6% in a year when rates fell from 2.77% to 3.07%.
It takes time for the rate hike to hit the economy – and the cooling effect may linger.
In the 12 months since the rate hike, southern California home prices have fallen 19% of the time since 1988, with the largest year-over-year decline being the 34% drop in August 2008.
Lower appreciation rates are more common when loans become more expensive. Southern California’s appreciation cooled 12 months after rates rose 61% of the time.
Price increases averaged 4.3% in the year following a rate hike, 3.7 percentage points below the pace of gains at the start of a rate hike. Basically, the appreciation has been cut in half.
Then look at the second year after the rate hike.
Price drops have occurred 23% of the time since 1988, with year-over-year drops as large as the 40% implosion in January 2009.
Again, decreased appreciation is the most common outcome – occurring 49% of the time. Southern California home prices only rose an average of 2.1% in the second year, down 2.2 points from the previous year. Or cut in half, again.
On a scale of zero bubble (no bubble here) to five bubbles (five alarm alert) … FIVE BUBBLES!
Let’s be honest. The Fed is raising rates to curb inflation, and soaring house prices in the era of the pandemic is a prime target.
More expensive mortgages should eventually shrink the bubble. History says that in the two years since the rate hike, home appreciation in Southern California is on average 74% slower, from 8% to 2.1%.
The big question is whether the Fed can skillfully use its rate-setting powers to gently cool the economy and its particularly foamy real estate market.
Be warned, this doesn’t always go as planned with real estate.
Forget the early 1980s, when the Fed intentionally froze an overheating economy – slamming housing in the process – with double-digit interest rates. And forget about the Great Recession, which ravaged real estate for many reasons other than previous rate hikes.
Instead, try to remember the early 90s.
The Fed estimated that in 1993 it had done enough to revive the economy after a mild US recession that was more intense in California. Mortgage rates, for example, fell below 7% for the first time in more than two decades. (Yes, 7%.)
The Fed’s “tightening” around this time resulted in mortgages staying above 7% for another five years. This expensive financing and other economic challenges such as a declining local aerospace industry have put pressure on housing.
The median price of $ 152,860 in Southern California for October 1993 – then the record – was not broken until September 1998.
It’s basically five years of zero gain. Another way bubbles can deflate.