Is It Time to Panic Over High Mortgage Rates?

On March 11, I named a fast-approaching long-term breakout in interest rates as one of the biggest developments in the markets.

Since higher rates affect all interest-rate related products, it makes sense that mortgage rates have reached 3-year highs.

According to Bankrate.com, the 3-year fixed national average mortgage rate is back above 4.5% (a level last seen in the beginning of 2019).

But this recent surge hasn’t been a slow march higher… 30-year mortgages were under 3.3% as recently as late December.

Historically, one could say they have exploded higher this year…

Many must be wondering if the recent surge in mortgage rates will put the brakes on rising real estate prices. After all, conventional wisdom often cites that rising rates means falling real estate prices.

But it also cites that rising inflation is good for real estate prices…

Now, we have both forces at work.

So which affects real estate more, inflation or rising rates?

History tells us it’s inflation, and that when it comes to real estate prices, rate fluctuations are simply market noise.

Take a look at this chart of median home prices (blue line) and mortgage rates (red line) from 1971 to 2021…

The last time we saw this level of inflation and rates rising this fast was in the 1970s. Back then, home prices were undeterred.

From 1971-1981, when rates more than doubled from around 7% to 16.5%, real estate prices rose 175%.

Over this 50-year period, there were 19 years where mortgage rates went up, yet home prices still rose 8% on average.

Based on this, one would think that during the years where mortgage rates dropped, we would see real estate rise even more.

After all, it’s more attractive to buy real estate when your interest expenses are lower – but it’s the opposite.  

Over the 31 years when rates fell, real estate only went up 4%. Meaning, they went up more with higher rates than lower.

So, this whole notion that people should be afraid to buy a new home or plan for some sort of correction in their home prices is not supported by anything (unless we’re in a bubble).

Some people call today’s real estate market a bubble. But it’s doing what it’s supposed to – reflecting higher inflation, material shortages, and labor costs. 

What we do see is a strong connection with inflation, which accelerates prices. But the trend always rises.

The only real noticeable blips in the home price trend came during recessionary periods (early ‘90s), and the big market collapse of 2008.

That’s something to keep an eye on.

Because if we’re heading into a recession, prices may stall or drop slightly – but nothing that should affect your decision either way.   

Right now, we’re still growing as an economy, but much slower than before.

With the Fed tightening, slower growth could turn into lower growth.

Many investors interested in real estate like to look at REITS (real estate investment trusts), but REITS are prone to overvaluation like any other stock.

For instance, the Dow Jones Equity REIT Total Return Index is down 9% this year along with the rest of the market.

But median home prices are still rising, and that’s a trend that’ll continue regardless of interest rates.

Regards,

Eric Shamilov
Analyst, Market Minute

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