Inflation Goes Up, Mortgage Rates Have to Go Up, so What’s Next for US Real Estate Market?

Generally positive economic news in March and April 2018 have led to a stronger US economy and a stronger labor market. This is causing higher mortgage interest rates. With that comes the risk of inflation. When there is a higher chance of inflation, the Federal Reserve usually raises rates faster.

The jobs report in March 2018 showed good growth with non-farm payroll employment increasing by more than 300,000. The labor market strength was very broad, as almost all industries saw increases in jobs from the month before. The stronger job market put more pressure on compensation, with wages going up 2.5% from the year before.

The Fed also noted earlier this year that it expected annual inflation to move higher but to stabilize in the area of 2%. The Federal Reserve has forecast 3 rate increases for this year, which is the same number as last year. But if wages continue to rise, this could increase inflation. Faster inflation will probably cause the Fed to increase rate increases.

So, if inflation continues to rise and the Fed raises rates more, what does this all mean for the housing market? Rising inflation will increase long term bond yields to pay investors for the higher amount of inflation. For instance, the yield on the 10-year US Treasury already increased .6% since the beginning of the year and just went over the psychologically important benchmark of 3%.

This affects the mortgage and housing markets because mortgage rates follow the pattern of long term bond yields. And rates have been on the rise. Recent rates for 30-year conventional mortgages that are fixed have been nearly 4.6%. This is up more than .5% from the start of the year. Rates have generally gone up every week this year, with a few breathers every month or so. Higher mortgage rates give buyers less buying power. This can be a problem especially as home prices have been climbing substantially, with home prices overall in the US 6% higher than 2017, according to recent data.

But, how much the rising interest rates and inflation will affect the housing and mortgage markets is debatable. After all, the root cause of higher inflation and home loan rates is increasing growth of wages. Average household income based upon Census data shows is as high as it has ever been. But even though mortgage rates are higher, they still are very low historically. Keep in mind that in the 40 years before the Great Recession in 2008, mortgage rates were never below 5%.

For 2018, exactly how much inflation and mortgage rates affect the real estate market come down to just how much household incomes rise, and how high rates climb.

Understanding More About Inflation and Home Prices

One of the key ways to understand how inflation affects housing prices is to think about all of the materials that go into building a home. There are a lot of commodities that go into building a house: wood, copper, glass, plastic, steel, etc. These are all very basic commodities that must be used to construct most houses in the country. When the prices of these materials rise with inflation, it costs the builder more to build the home. They will either make less profit or increase the price. In most cases, they will increase prices. Higher cost of commodities are usually passed onto the consumer.

Another effect of increasing inflation is, as we noted earlier, is increasing interest rates as the Federal Reserve raises them to reduce inflation. So, it becomes more expensive for consumers to borrow money. Fewer people are able to get loans and fewer homes may be built. But higher wages and economic growth can counter some of this.

If more people are unable to afford higher rates and higher prices (if these effects are outweighing rising household wages), more people may start to move into rental properties. This is not good for single family home sales, but it can sure help landlords!  Some landlords may even decide to buy or build more multifamily homes.

One interesting fact of home ownership is that owning protects you against inflation in large part. For most Americans, their biggest expense is their mortgage. But most people have fixed rate mortgages, so no matter what is going on in the real estate and financial markets, you have the same fixed mortgage at the same rate. You are now paying off your mortgage with dollars that are not as valuable as when you took out the loan. While owning a home does not always make you wealthy, it sure can protect you against inflation.

We will need to watch for the rest of the year to see if rising inflation will cause rates to have to go higher. The Fed may decide to do so. If so, it is debatable whether the real estate market in the US will cool. It could in some areas where wage growth is not keeping up with inflation, but not in hot real estate markets.




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