Real Estate: Rising Mortgage Rates And Housing Outlook

Includes: ITB, IYR, XHB
by: Markos Kaminis

Mortgage rates have been trending higher and have raised investor concern about their impact on the real estate market.

Today’s economic environment and market position are different than comparable periods, and mortgage rates are still extremely low.

Demand for housing should burgeon as the fully employed workforce that is confident in the economy overcomes old financial burdens and readies for homeownership.

Mortgage rates rose again last week, marking a new four-year high and continuing a trend of the last nine weeks. We know rising mortgage rates can become problematic for housing formation. So is this going to be a problem for the real estate sector? Well, it did not stop applications for home purchases last week, and I do not believe it will stop housing growth this year either. The economy is too strong, and data published Thursday by Freddie Mac seems to indicate market concerns may be overdone.

Mortgage Applications Data

The Mortgage Bankers Association (MBA) this week reported its Weekly Applications Survey for the week ended March 9th. Applications for mortgages increased 0.9% week-to-week on a seasonally adjusted basis. The increase was fully due to applications made for the purchases of homes, as purchase applications rose 3.0%. Refinances of mortgages decreased 2.0%, as 30-year fixed rate mortgage rates increased for the ninth straight week, advancing to their highest level in over four years.

Rising mortgage rates are having an impact on mortgage refinancing activity. Mortgage refinances as a percentage of total mortgage applications declined to 40.1% last week, its lowest level since September 2008. Things were heading in the wrong direction back then, and people could not refinance because the value of their homes were dropping to below their equity in the home, and because they were losing their jobs. Today is a different story, with the great majority of mortgages that would refinance having already gone through the process given the duration of low mortgage rates. Though, the improvement of household income and home values for some has allowed more homeowners to lower their cost of financing.

The average contract interest rate for 30-year fixed rate mortgages with conforming loan balances marched to its highest mark since January 2014. The rate climbed four basis points to 4.69% last week, though average points decreased to 0.45 from 0.58 the prior week. The message was mixed across mortgage types, though, with 30-year fixed rate mortgages on jumbo loan balances and 15-year fixed rate mortgages seeing decreases in contract rates. Still, many are wondering now whether rising mortgage rates are impacting home sales.

Home Sales Recently Eased

Headwinds have picked up in the real estate market, though the economic tailwind is still strong. Still, recent home sales data, both from existing properties and new homes, were disappointing.

January existing home sales declined for the second straight month, falling 3.2% month-to-month, however softness in January is regular against December. Still, this January's sales pace also fell short against the prior year period, declining 4.8% year-to-year. We attributed the decrease to the extremely short supply of homes for sale that is causing a bottleneck between supply and demand.

New home sales reported for January fell to an annual pace of 593K, from 643K in December (revised from 625K). The prior month was exceptional, however, January's sales were down 1.0% year-to-year. The annual declines in sales pace are important, and while much attribution for it is due to extremely tight supply, there's more than that at play today. We discussed the possible impact of trade war on housing in a recent report. Rising mortgage rates, however, are a current threat.

Interest Rates Are Rising

For various reasons, 30-year treasury yields were up 36 basis points year-to-date through March 13. Mortgage rates (historical mortgage rate data) on 30-year fixed rate mortgages are up 70 basis points year-to-date; that's a lot for 2.5 months' time. We know that rising rates can have a way of slowing home sales, so just how important is this headwind?

Are Rising Mortgage Rates a Critical Headwind?

Freddie Mac recently published in its Insight publication a report on how rising mortgage rates might impact housing. An important point made by the piece, and one the market seems to have initially ignored, is that it matters how much rates will rise and how fast they will. There is some indication this week that the trend may be breaking or easing, as mortgage rates backed down.

The Insight report starts with a comparison to the 18% mortgage rates of 1981, but I found it quite startling that in 1981 with rates that high, single-family housing starts still marked 705K. That compares with the most recent reporting of single-family housing starts at 877K. Imagine, housing starts in 1981 fell 51% to that point, from a healthy housing market in 1977 that boasted low mortgage rates of, get this, 8.0%.

I think this relative data should help put things into proper perspective for you, and help reassure real estate enthusiasts about the current state of affairs. Rates are still relatively low and housing sales have room to grow to a more normal level that would be appropriate for the re-energized economy and populace.

The Fed and the market respectively see 3 to 4 rate hikes of 75 to 100 basis points for this year for the Fed Funds rate. The Insight article refers to similar periods, sort of, where mortgage rates rose by more than 1.0% from trough to peak. The largest measured increase of six such instances since 1990 was just 2.4 percentage points. However, the depth of rates at this trough, and the recoil back to normal after one of the worst real estate crashes in American history, leads me to believe we'll exceed 240 basis points this time around. It is unlikely we would come close to reaching 18% mortgage rates in the current cycle, but some of the fiscal policies (tariffs for instance) being put into place today are inflationary in nature and unorthodox, so perhaps unorthodox mortgage rates are possible again.

The data definitely shows that housing activity slows when rates rise, as measured by housing starts, mortgage originations and home sales. But the rate of change in rates and the peak rate will matter greatly, along with other factors, like the economy, stupid. Global economic rejuvenation alongside tax reform policy and other expansionary policies in America give the economy a good chance at bearing the burden of rising mortgage rates. A fully employed workforce, with rising compensation (it's coming), packs a punch. So, a stronger American can bear a greater cost of home ownership.

Still, shouldn't we be concerned, considering the recent slowdown in home sales reported above? I do not think so, for a couple reasons. First, Americans are still building up their financial strength, ridding themselves of old credit burdens etc. With time, the American consumer will grow stronger, and his high confidence will translate into bigger spending. Also, the economy has faced sluggishness in the first quarter of the year a couple times in the last few years. There is something else at play here, and this season's slowdown may simply be a continuation of that trend.

Housing Relative Stocks


SPDR S&P 500 (SPY)


SPDR S&P Homebuilders (XHB)


iShares US Home Construction (ITB)


iShares US Real Estate (IYR)


Housing relative shares are off this year against the market on the slowing sales data and gusting headwinds in rising mortgage rates and other pressures. However, I suspect this is a buying opportunity, as the economy is still humming and Americans are employed and stocking up cash to buy homes long overdue them. For more of my regular work on real estate, readers are welcome to follow the column here at Seeking Alpha.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.