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  • Writer's pictureHugh F. Wynn

Will Rising Mortgage Rates Finally Burst the Housing Bubble?

Home buyers still in search of a house were dealt a blow this week when the Fed announced an increase in the federal-funds rate by three quarters of a percentage point…the second such increase in as many months. Here's how that news - and other economic factors - are affecting the once-scorching housing market. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

22-Year Low

According to the Mortgage Bankers Association (MBA), mortgage demand (both mortgage applications and refinancing volume) is at a 22-year low, dating back to George W. Bush’s first term. (Remember those long-lost days of a buck-fifty per gallon of gasoline?)

There are a lot of reasons why mortgage demand is currently slowing:

  • 30-year fixed rates doubling since January 2022

  • Rampant inflation

  • Concerns about a possible recession

  • Affordability issues emanating from all of these major economic concerns

This combination of higher prices and higher mortgage rates is clearly impacting housing market dynamics, including refinancing – which dropped 4% over the last week and 80% over the last year.

Lagging Loan Demand

Both conventional and government loan demand continued to drop for the third consecutive week, with more anticipated. Last week, demand slipped 6.3%. However, despite this softening, home prices aren't falling…yet.

June 2020 marked another all-time high in median home prices - $416,000 - up 13.4% on the year. This is the highest since collection of such records began in 1999, according to the National Association of Realtors. NAR also reported that in June 2022 – for the fifth straight month – sales of previously owned homes dropped 5.4% to an annualized rate of 5.12 million - a figure lower than the number of sales recorded in all of pre-pandemic 2019.

Inflation’s Impact

The U.S. economy shrank at a 0.9% annual rate in the second quarter - a second straight quarterly decline in GDP. Despite the heated debate you hear from the chattering class and politicians, this is a common definition of recession. My own definition is an ever-shrinking wallet.

Soaring prices, combined with the doubling of mortgage rates, are having a predictably negative impact on homebuyer sentiment. It fell sharply in July 2022, which, by extension, further accelerated pessimism among home builders. And yesterday’s Fed announcements are likely to accelerate those trends. According to the National Association of Homebuilders (NAHB), this decline in mortgage demand has occasioned a builder confidence decline of seven months to NAHB’s lowest-ever reading (excluding the early pandemic).

Price “Softening”

Despite the current supply-demand disequilibrium in residential housing, the US is likely to see little more than a “softening” in home values in the short-term. Previously-owned home sales hit a two-year low in June with minimal impact on price. Still, the doubling of mortgage rates has discouraged many first-time and lower-income buyers from entering the market. And steely-eyed lenders are dissuading some higher-income buyers - those with less than stellar credit - from qualifying for loans. Builders are alert to these trends and responding with fewer construction starts, which is adding to the housing supply challenge.

Inventory Issues

Still, despite higher prices, homes are still selling fairly quickly. This is a curious dichotomy. In June, homes remained on the market about 14 days, the lowest dating back to 2011. The number of homes for sale has increased, but is still a low three-months supply. Inventory at the end of June stood at 1.26 million, an almost 10% increase over May. But with mortgage applications down, some suggest that demand could fall in the weeks and month ahead.

The housing market has definitely cooled nationally despite low inventories. Mortgage applications and refinancing volume are at a 22-year low as previously mentioned for obvious reasons, including inflation, a doubling of 30-year fixed rate mortgages, an increasingly negative outlook on a weakening economy, and the affordability issues associated with all of these factors.

Texas Markets

Home sellers in the Houston area have reduced their asking price in the face of fewer buyers. Zillow estimates that the 17% of Houston homes for sale saw price cuts in June versus 11% a year earlier. Does this mean the advantage is shifting to buyers? Not necessarily - yet - but Texas metro market sellers are definitely adjusting their expectations a bit.

Houston sellers appear to be under less pressure to reduce prices than other major Texas markets. For example, the wild and wooly Austin metro market experienced the biggest percentage of price reductions in the Lone Star State’s major markets…almost 42% of Austin homes for sale lowered asking prices in June versus 15% a year earlier. That's an attention-grabbing change considering the recent "gold rush" on Austin real estate. The Dallas and San Antonio metro area reductions were each about 38%.

Market Disequilibrium

Even though the Texas market is softening, sales prices are still rising. But at a slower pace. Why? At its core, there is a supply-demand disequilibrium in the housing market…a shortage of homes. In the presence of this conundrum, there is likely not to be a crash - or bubble burst - in home values despite the high values achieved.

Texas Tea

The continued attraction of out-of-state buyers from the east and west coast markets (where prices are mind-boggling) to Texas is a plus for Texas home sellers. And the flexibility of more folks working remotely and who are attracted to the lower cost-of-living in Texas adds to its sustained market strength . According to Redfin, Houston, Dallas and San Antonio rank 11th, 10th and 9th, respectively, on their list of top metro areas where folks are looking to move.

And smaller Texas cities are also faring well, according to a recent Wall Street Journal article:

Low-cost cities with strong economies fared well in the second quarter as high prices and rising mortgage rates caused a swift slowdown in the housing market. The highest ranking small Texas city in this group was Waco at 27. Next highest was Killeen-Temple at 55 and Wichita Falls at 56. Austin-Roundtop ranked 63.
As remote or hybrid work schedules have become more common, households are willing to relocate for cheaper housing or a better quality of life, pushing small, affordable markets to the top of The Wall Street Journal/ Emerging Housing Markets Index in the second quarter. Elkhart, Ind., a metro area of about 206,000 people, was the top-ranked market for the quarter. The top 20 cities have an average population size of about 400,000. [It seems] the cost premium of living in a city like San Francisco or New York has lost its allure.

In Sum

From a personal perspective, I find it difficult to believe that home values will drop much - if at all - in the near term in the face of today’s significant supply shortage. But the supply-demand equation is a double-edged sword. If mortgage rates continue to increase, inflation leads to ever-higher construction and labor costs, and the Fed’s battle to control inflation results in a widely anticipation recession (is it already here?), then another round of falling housing demand could result in a supply-demand equilibrium - not from an increasing supply of homes, but from reduced demand. Perhaps, this moment is a time for reflective patience - both as a buyer and as a seller.

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