Higher Interest Rates a Near-Term Speed Bump for Home Price Appreciation

Friday, December 16, 2016 by Zelman & Associates

Given transparency in home prices through multiple listing services and public records, there are an abundance of data providers tracking the market. To simplify the discussion, we rely on our aggregate existing home price index that incorporates data from five different sources. Our goal is to provide a big picture perspective of how we think about home prices that can aid the spectrum of analysts focused directly on the housing market to those looking to incorporate our outlook into a macro analysis around consumer spending or economic activity.

As of September, our existing home price index was up 5.8% year over year, the best measure since January at 6.1%. Speaking to seasonally-adjusted strength of late, the sequential change for September was the best since 2005 while the sequential increase for the third quarter was better than each of the last two years.

Over the last 28 months, year-over-year home price inflation has been consistently in the 5-6% range, speaking to continued momentum in household formation and limited for-sale inventory, in our opinion. In addition, given the lagging nature of existing home price data, it is likely that recent momentum was aided by the downward trend in interest rates that prevailed through the first three quarters of the year. For example, the 30-year fixed mortgage rate averaged 3.45% in 3Q16 versus 3.90% in 4Q15, which equates to increased purchasing power for an entry-level homebuyer of 4-5%, all else equal.

Now, the shoe is on the other foot as the recent spike in interest rates has been an effective price increase to potential homebuyers. Consider that the 30-year fixed mortgage rate is expected to average 4.50% in 2017, 85 basis points higher than in 2016. If realized, that annual increase would be the largest since 1994. Assuming home prices increase approximately 4%, it would also mean that the entry-level monthly payment, inclusive of mortgage insurance, would increase 14%.

We believe that entry-level affordability is still in a very favorable position when comparing payments to income; however, a double-digit increase in the monthly payment has only occurred in three other years since 1990 – 2000, 2004 and 2013. As such, we expect a short-term digestion period for consumers that is likely to result in softer home price appreciation next year. Zelman & Associates now forecasts year-end national existing home prices to increase 5.2% in 2016, 4.1% in 2017 and 3.7% in 2018. An offset to this view could be a stronger national economic narrative and improving mortgage credit but at this point we prefer to be more conservative.

Higher Interest Rates a Near-Term Speed Bump for Home Price Appreciation

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