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The Fed’s gambit is working. The increase in mortgage rates lowers prices in metro Atlanta in the short term, but in the longer term, these increases will reduce supply at a time when there are no buyers and housing shortages in the region.
Freddie Mac estimates there is a 1.5 million housing shortage in the U.S. due to the arrival of the millennial generation and their need for housing. By simple extrapolation, the metro Atlanta area is about 30,000 homes short.
Add to that the fact that Atlanta’s population is growing by 60,000 people a year, and you can expect the demand for housing in Atlanta to be very high. This. And that developers are trying to build as many houses as possible. They are. And that all this is supported by high and rising prices. It was.
Mortgage rates have risen at an unprecedented rate over the past six months, from 3.5% to around 6.5% currently. Higher mortgage rates lower home prices, reducing affordability:
- A 1% increase in the mortgage rate leads to a 10% decrease in purchasing power.
In other words, a buyer with a budget of $1 million with a mortgage rate of 3.5% can only afford a home for $700,000 with a mortgage rate of 6.5%. The mortgage payment is about the same for both. Buyers respond by lowering prices or exiting the market.
But mortgage rates are a double-edged sword in the housing market. Many sellers are also buyers, and sellers follow the same pattern as buyers, but at a slower rate. The latest statistics confirm this trend:
- In the last 12 months, demand in Atlanta is down 50% as measured by FMLS® ad impressions.
- Supply (new listings on FMLS®) is down 20%.
Demand is falling faster than supply, which usually happens when the Fed raises interest rates. A shorthand measure of supply and demand is the inventory level, which consists of listings divided by average monthly sales. Stocks, as expected, are therefore rising.
- Inventory has increased by 80% in the last 12 months from 1.2 to 2.2 months of inventory.
Increased inventory usually leads to lower prices, but here comes the supply-demand mismatch in metro Atlanta:
- Greater Atlanta home prices in December 2022 were 5% above December 2021 levels and 9.5% below the June 2022 peak.
Two-month inventories are well below historical figures, which are close to 5-month inventories, and thus prices have not fallen sharply. Sellers may or may not be picky, but with fewer buyers and increased competition from other sellers, prices have fallen from their peak.
To understand what will happen to prices in the future, we need to consider the outlook for mortgage rates and inventories.
Where are mortgage rates?
The only thing investors now know with certainty about the future is that the Fed will continue to raise rates to fight inflation. This creates fear of recession. Rising short-term rates and fears of a recession do not make for a healthy economic outlook or housing market. Current mortgage rates reflect this assessment.
Mortgage rates traditionally track the 10-year Treasury rate, which is the leader of long-term rates. The difference between the two rates is called the spread. In times of uncertainty, the difference between the 10-year T-Bond rate and the 30-year mortgage rate widens. The chart below shows the history of this spread over the past twenty years. Note the current surge in the spread to three percentage points:
The 10-year Treasury rate is currently around 3.5% and the mortgage rate is around 6.5%. The current spread, 300 basis points (bp), is well above the more common spread of 150-170 bp.
Mortgage lenders are now demanding higher premiums because of heightened fears of defaults and defaults in the wake of a potential recession. Notice in the chart above that the other two peak spreads were in 2008, during the Great Recession, and in 2019, during COVID. In both cases, the spread declined only after the Fed began cutting rates to fight the recession.
The Fed has been very clear in its commitment to stopping inflation by raising interest rates. At least two more rounds of tightening are expected. In the absence of a clear signal of improvement in the economic outlook, the risk premium will remain.
- Therefore, it is reasonable to anticipate that mortgage rates will remain in the current range of 6% – 7% until the 2nd and possibly the 3rd quarter of 2023.
- The risk premium will dissipate and mortgage rates will decline as the Fed signals an easier profile and/or the economic outlook brightens.
- Mortgage rates are expected to drop to the 5% to 6% range (assuming the 10-year T-Bond rate is 3.5%).
Higher mortgage rates will continue to dampen demand and supply will continue to outstrip demand as new construction comes online and cash-strapped sellers put their homes on the market. However, growth rates will be slow. A return to the 5-month inventory, a more normal position, is not foreseen in the near future.
Atlanta’s housing market has been, and should remain, extremely resilient given the growth in mortgage lending over the past year. This reflects a fundamental mismatch between supply and demand in much of Atlanta. Rising mortgage rates temporarily dampened demand, but when rates begin to decline, the demand floodgates will reopen and prices will return to and exceed the 2022 peak.
At the same time, the forecast for next year is moderately bearish. All activity – buying, selling and building – will slow down. Inventory will continue to rise slowly, and prices will be more in line with 2021 pricing than 2022 pricing, about 5% below 2022 highs in much of Atlanta. However, the greater Atlanta area covers a very large geographic area, and individual submarket areas can and will vary from this trend.