During the zenith of the lingering Home Owners’ Equivalent Rent (OER) inflation in mid-2023, a notable dichotomy materialized: while the Zillow rent inflation benchmark had been descending for a year to less than 5% rate, the official OER was still over 8%. Since then, OER retains a 5.4% tenant inflation today despite the more accurate Zillow rate falling to a norm alized 2.6%. This OER component that disproportionately influences the Consumer Price Index (CPI) by a substantial 34% has overstated inflation. Excluding housing costs, true inflation appears to align more closely with the Federal Reserve’s prescribed target of 2%.
As unemployment inches beyond 4% and economic growth dips below 2%, a preemptive rate reduction by the Fed seems warranted ahead of the impending elections. Political acrimony over the Fed putting their thumb on the political election scale will understandably ensue. A rate cut would signify the Fed’s confidence in averting a resurgence of inflationary pressures and boost equities. In fact the broader stock market beyond the Mag 7 tech giants are already responding positively in anticipation of expected rate cut stimulation. Nonetheless, prospective homebuyers may need to await the passage of a year or two with rate cuts in the rear view mirrorr to witness ameliorations in affordability levels.
The assertion that genuine inflation has now plateaued at the Fed’s arbitrary 2% benchmark does not diminish the palpable monetary strains borne by average households resulting from the prolonged period of excess stimulus over the past three years. Household expenditures have outpaced income growth, with soaring energy, food and housing sector inflation exerting particular strain on consumer sentiment. A noteworthy statistic reveals that approximately 30% of households allocate 35% of their income toward rent and utilities, underscoring the weight of housing expenses on families.
The past three years have witnessed a staggering 20% surge in rental prices, surpassing the customary growth trajectory by a considerable margin. To recover from the price shocks endured in 2021 and 2022, individuals may require a buffer of at least a couple of years characterized by stable inflation below 3%. Current surveys reflect a prevailing sentiment of economic apprehension due to past inflation and current interest rates and thus content to keep their homes off the market.
Historically the average mortgage rate loan for existing homes stays in close proximity to the current rate for new borrowers. Higher prices for goods create larger supplies in response. However, the sudden mortgage rate rise from record lows during Covid has created an enormous spread that explains why the supply of homes for sale are so low despite record high prices.
Enterprising homebuyers have resorted to Adjustable-Rate Mortgages (ARMs) in a bid to evade the soaring fixed mortgage rates that attained a two-decade high in 2022. The comparative allure of ARMs, garnering approximately half a percentage point less than the 30-year fixed mortgage, has enticed buyers amidst the escalating mortgage rate landscape. While housing affordability levels mimic the exorbitant standards witnessed during the 2006-2008 housing bubble, mitigating factors, such as a constrained supply, temper concerns of a reprise of that tumultuous period.
The allure of record-low Covid induced mortgage rates in 2020 and 2021 fuelled a surge in refinancing and new acquisitions, thereby distorting market dynamics. However, with borrowing rates tripling since that epoch, potential sellers have opted to retain their properties to evade the burden of acquiring loans at exorbitant rates exceeding 7%. Treasured bygone eras of 2 to 4% mortgages appear unattainable in the absence of a substantial economic downturn. A burgeoning inventory of existing homes, coupled with the aging boomer demographic increasingly divesting properties, will likely prompt a market rebalance, fostering enhanced affordability in due course when the economy slows and rates move back into the 5’s. Nevertheless, discerning buyers are urged to exhibit patience as they await a conducive environment characterized by diminished rates and increased housing stock before embarking on significant property investments.
