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Despite rising rates, housing market expected to thrive

by Kerrie Kennedy

Will the housing market remain resilient to rising rates? A new report that measures the impact of income and interest rate changes on consumer housing-buying power suggests that even if rising rates persist in 2021, the housing market is likely to continue to thrive.

In fact, the latest First American Real Home Price Index shows the real home prices actually declined 6.2% year over year in November, even though nominal house prices continued to surge.

Consumer house-buying power — how much one can buy based on changes in income and interest rates — increased 18.9% year over year. Median household income has also increased, up 5.8% since November 2019 and a whopping 72.1% since January 2000.

“Affordability improved in November as two of the three key drivers of the RHPI household income and mortgage rates, swung in favor of increased affordability,” said First American Chief Economist Mark Fleming in the report. “While mortgage rates fell in November, in more recent data from January 2021, mortgage rates have increased slightly due to a more positive economic outlook. Historically, when mortgage rates rise, existing-home sales don’t necessarily fall.”

The report examined how the housing market responded to six significant rising-rate eras over the last 30 years.

“The 2005-2006 rising-rate era preceding the 2008 housing crisis stands out because existing-home sales fell dramatically,” Fleming said. “Existing-home sales also decreased in the 1994 rising-rate era, as the Federal Reserve increased the federal funds rate to prevent strong economic growth from feeding inflation. However, in the four other rising-rate eras we examined, existing-home sales increased (1996, 1998-2000, 2013), or only declined after prolonged resistance (2017-2018). Context matters and each rising-rate era is different. The housing market response depends on the reason why rates are rising.”

The report also looked at how unadjusted house prices reacted in the same six rising-rate eras.  Aside from the 1994 rising-rate period, when house prices declined slightly and briefly, house prices have always continued to rise, albeit more slowly, when rates have increased, Fleming noted.

“In the 2005-2006 housing bubble, house prices eventually declined after initially increasing, but never declined below the level at the beginning of the rising-rate era. “In the longest rising mortgage rate era, 1998-2000, nominal house prices increased consistently with the economic recovery from the previous recession. House price appreciation is resistant to rising mortgage rates primarily because home sellers would rather withdraw from the market than sell at lower prices – a phenomenon we refer to as ‘downside sticky.’” 

The lesson is that context matters. “Rising interest rates reduce house-buying power and affordability, but are often a sign of a strong economy, which increases home buyer demand,” said Fleming. “By any historic standard, today’s mortgage rates remain historically low and will continue to boost house-buying power and keep purchase demand robust. At the same time, millennials aging into their prime home-buying years and a limited supply of homes for sale make for a housing market that well positioned for rising rates.Economic and demographic context matters and, even if rising rates persist in 2021, the context is good for the housing market.”

The report noted that real house prices are 26% less expensive than in January 2000. While unadjusted house prices are now 19.4% above the housing boom peak in 2006, real, house-buying power-adjusted house prices remain 48% below their 2006 housing boom peak.

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