The Impact of Higher Interest Rates on the Housing Market | U.S. Bank (2024)

One of the biggest economic stories that resulted from the Federal Reserve (Fed) hiking interest rates beginning in 2022 has been the impact on the housing market. It was the segment of the economy, more than any other, that was negatively affected as the rate environment changed. Higher mortgage rates initially slowed demand, then dampened housing supply, particularly for those in the market for existing homes. Yet in February 2024, existing home sales made their largest monthly gain in a year,¹ a hopeful sign for this segment of the housing market.

Although higher mortgage rates initially dampened housing demand and drove home prices modestly lower, prices have recovered. In this unusual environment, with a combination of rising home prices and the highest mortgage rates in more than 20 years,² potential homebuyers face a budgeting challenge to manage higher monthly payments. Nevertheless, housing demand remains strong.

Impact of higher interest rates on the housing market

“The biggest changes to the housing market landscape have already happened,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “With the Fed apparently done raising rates for now, a degree of uncertainty is removed from the market.” Haworth notes that those in the home-buying market shouldn’t have to worry about another spike in mortgage rates. “That allows people to better plan as they determine what they need to budget for housing costs.”

Home prices recover

Home prices, like those for any product or service, are driven in large part by supply and demand. Prior to 2022, supply lagged demand and home prices skyrocketed. But after Fed rate hikes began, housing demand dipped and prices followed suit, falling between July 2022 and January 2023. But according to the S&P CoreLogic Case-Shiller 20-City Composite Home Price Index, home values fully recovered from that seven-month decline. By October 2023, average home prices nationwide reached new, all-time highs, but values slipped modestly since then. Still, home prices, based on this national average, are up 6.6% from a year earlier.³

“Some who track the housing market predicted that average home prices nationally would fall by 10-15%,” says Matt Schoeppner, senior economist at U.S. Bank. Yet at their low point in the current cycle, home prices (based on the Case-Shiller Index) were down only 6.8% before rebounding to new highs.³

For all of 2023, mortgage applications for home purchases fell to their lowest levels since 1995. In mid-March 2024, the unadjusted Purchase Index for mortgage applications was 14% lower than the same week a year earlier.⁴

Following a modest increase in January, existing home sales jumped 9.5% in February, representing a seasonally adjusted annual rate of 4.38 million homes sold. Previously, annualized home sales had lingered below 4 million, a historically low number. A concern up to this point is that existing homeowners who potentially would consider selling their homes are reluctant to do so because they are locked into lower mortgage rates they obtained before rates moved higher. “The uptick in existing home sales over the 4 million mark is significant,” says Haworth. “It may mean people who put off moving due to higher mortgage rates are deciding to sell their homes and purchase another home, even with higher financing costs.” Nevertheless, the pace of existing home sales is 3.3% lower than at the same point in 2023.¹

Homebuyers are increasingly turning to the new home construction market. New-home sales continue to strengthen, up 5.9% in February 2024 compared to a year ago. New home sales stood at a seasonally adjusted annual rate of 662,000.⁵ Haworth says new home sales help meet demand, but only partially. “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 2023.⁶ That represented the highest mortgage rate since November 2000. The result is more costly borrowing, which can dampen housing market activity. Rates declined from October’s peaks, but are still close to 7%.⁶

Higher mortgage rates and home prices may keep many potential buyers on the sidelines. According to the residential real estate brokerage firm Redfin, the median monthly mortgage payment in February 2024 (based on average 30-year mortgage rates and home prices) was $2,685, down from an all-time high of $2,735 in mid-October, but up 1.9% from February’s median mortgage payment.⁷ However, steeper monthly mortgage costs continue to be a burden for those looking to purchase a home. “The combination of higher home prices and elevated mortgage rates creates a meaningful headwind for new homebuyers,” says Haworth. “They either need to be able to make a bigger down payment or they must earmark more of their monthly budget for housing costs.”

Impact on real estate investing

For those looking to add diversification by including real estate in their portfolios, a commonly used vehicle is a real estate investment trust (REIT). However, higher interest rates create headwinds for REITs.

“Real estate as an asset class was one of the first to be repriced lower in reaction to higher interest rates,” says Tom Hainlin, national investment strategist at U.S. Bank Wealth Management. “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,” Hainlin says. “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. However, after spending much of 2023 in negative territory, REITs enjoyed a modest rebound at the end of the year. For all of 2023, the S&P Developed REIT Index gained 11.69%. Despite the rally, REITs significantly trailed gains of 26.29% for the broader S&P 500, a benchmark measure of U.S. stock market performance. Year-to-date through March 25, 2024, REITs are again in negative territory, with the Developed REIT index down 3.36%, compared to a year-to-date total return of 9.78% for the S&P 500.⁸

Haworth points out that certain types of REITs have performed better. “Data centers, cell towers and light industrial properties have generally been the best performing REIT sectors as demand remains strong,” says Haworth. “The REIT market is struggling overall, however, due to persistently high interest rates.”

Housing market’s influence on economic growth

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.

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