For Everyone

Interest rates and inflation: understanding the market in 2022

June 23, 2022

The US economy is in a turbulent state, with inflation hitting 8.5% in March 2022 – the highest increase in 40 years. This increase is driven by supply chain problems and monetary policies. With high inflation, mortgage rates have also started rising, indicating that the economy may be overheating. On top of that, energy prices have surged by more than 34%, causing almost everyone to tighten their belts on utilities usage. But what does this mean for home buyers and sellers?

As a real estate investor, it is your responsibility to do thorough research on the housing market before making any investment decisions– not putting in that effort would be tantamount to burning money. But if you're confused by the fast-changing rates and unpredictable trends, don't worry - you're not alone.

We've created this simplified guide to help you navigate the 2022 housing market and understand what’s causing it to run so hot.

Factors affecting the real estate market

Housing prices grew 17.1% YoY in Dec 2021, and the market seems to be skewed heavily in favor of sellers. However, this doesn’t mean all hope is lost for buyers. To understand why this is happening, let's review the significant economic indicators influencing real estate prices right now:

1. Rising interest rates

Interest rates have a massive impact on the housing market. The prime interest rate is currently at 4.75% and continuing to rise at an alarming rate. This is a result of the Federal Reserve trying to slow down the economy by deliberately raising interest rates and making borrowing more expensive. The Reserve is betting that high interest rates will stop the enormous rise in inflation, keeping the dollar at a stable value.

Since the beginning of the COVID-19 pandemic, the Federal Reserve has implemented five stimulus programs to facilitate the economy. These strategies boosted people’s disposable incomes, which, in turn, encouraged them to spend more. The new interest rate hikes are an attempt to now curb the highest inflation the country has experienced in decades.

High interest rates make it tougher to borrow money or get a mortgage for your new home, adversely impacting your purchasing power in real estate. In effect, real estate investments are taking a hit to stop the stock exchange from going into free-fall – an event which would precipitate a period of economic depression.

2. Declining mortgage affordability

When the pandemic first hit, interest rates went down to nearly zero, resulting in all-time low mortgage rates. This made buying a home an extremely attractive opportunity. However, since interest rates are now rising, the cost of borrowing has increased, making it more expensive to finance a home. In fact, the estimated monthly mortgage payment for a typical home rose 25% YoY, with a record-breaking median asking price of $376,000 for newly listed homes.

Affordability takes into account the price of the property and the interest rates. If both these factors are rising, affordability starts to decline. And when affordable mortgages are scarce, fewer people will have the ability to buy. In markets with very high interest rates, single-home buyers are often edged out by investors in bidding wars. Investors are able to afford high-interest mortgages because US tax law allows that interest to be written off as a business expense, thereby lowering the investor’s taxable income. Even though home buyers are allowed to list their first or second home’s mortgage interest as an itemized deduction in their personal tax filings (on mortgages up to $750,000), investors operating as LLCs or incorporated companies end up with the better tax break in a high interest market.

3. Increasing demand

Traditionally, high interest rates and low affordability put downward pressure on demand. However, demand is not currently falling in the present scenario, in line with what market forces would predict. Instead, the seemingly indefinite rise in interest rates is causing fluctuations in demand for housing as buyers rush to lock in as low a mortgage rate as possible. Even if home buyers decide to put off purchasing in hopes of better rates in the future, investors are continuing to buy property. With large amounts of cash at their disposal, property investors comprise the lion’s share of transactions at the moment.

4. Low housing supply

To add to the demand problem, housing inventory is extremely low and has been declining for some time now. Active listings have declined by more than 28% since January 2021, while new listings declined by almost 10% between January 2021 and January 2022.

Even if the demand for home purchases decreases due to higher costs and mortgage rates, it is likely that the number of housing units available for purchase will still be insufficient compared to the demand. Low housing supply will therefore put upward pressure on the prices and counteract the lower affordability issue, which will only lead to more demand. In this way, housing unit shortages dampen the effect of the declining housing prices.

There are several reasons for the limited inventory of housing units and their inability to keep up with rising demand:

  • A lack of space to build homes in many urban and suburban neighborhoods. Municipalities often zone open land for specific uses, such as building parks or areas for recreational activities.
  • The supply of labor is going down while building material costs are going up, making it more expensive and difficult to construct new homes.
  • Local zoning restrictions have prevented the construction of multi-family units in many areas, which could otherwise have increased housing supply and accommodated a larger number of people. Instead, the majority of homes that receive permits to be built are single-family units.

Low housing supply is a structural problem within the real estate industry that requires government intervention through supply-side policies. Addressing the shortage can help balance out demand and bring down prices to more sustainable levels. As of now, the most obvious impact of fewer housing units is a higher cost of living, which brings us to our next point.

5. Rising rent prices

Rents were up 4.2% YoY in February, making housing more expensive. However, this wasn't the case at the beginning of the pandemic. As mentioned earlier, the initial rise in housing demand was a result of historically low interest rates.

People want to sell their homes to move into bigger and better ones, but not at the cost of being stuck without a home due to decreasing inventory. Sellers looked for a new home before putting their home on the market, which created a loop of sellers doing the same and brought us to where we are now: high demand, low supply, and consistent sales over the asking price. This led to a hot market and lots of overwhelmed buyers willing to waive inspection contingencies and other crucial steps to make their offers more attractive to sellers.

Outlook of the housing market

There are a few key takeaways for home buyers and real estate investors:

  • While the rising mortgage rates are concerning, they are still historically low compared to the rates experienced from 2006 to 2008. Given the forecasted interest rates hike, it might be a smart move to lock in a fixed low rate for your mortgage while you still can.

  • At the moment, real estate appears to be a relatively stable and more attractive asset than equity or cryptocurrencies. The US stock market has been volatile amidst events like the pandemic, Federal interest rate hikes, and the war between Russia and Ukraine.

  • Long-term investors can benefit from investing in real estate as housing prices are likely to maintain their upward trajectory, despite short-term fluctuations. This gives you an opportunity to profit from rental income and appreciation.

  • Good deals are hard to come by right now. So if you’re looking to buy a home and find something you’re interested in, act quickly (albeit cautiously) to take advantage of the deal. Your real estate agent can help you evaluate deals, make quick decisions, and effectively negotiate with sellers.

Is the market going to crash?

It is undoubtedly challenging to navigate the current circumstances. On one hand, rising interest rates and low affordability put downward pressure on the housing market. On the other hand, low supply and rapidly increasing rent put upward pressure on the market. In effect, more people are looking for homes than there are available homes. And these conflicting circumstances are made more urgent by rumors and speculation that the market could crash as it did during the subprime mortgage crisis of 2008.

However, the fear of a market crash is overblown: the current real estate market is nothing like it was in 2008. The housing bubble of 2008 was buoyed by the circulation of subprime mortgages and loose lending guidelines. As a result, people with bad credit defaulted when adjustable rates on their mortgages grew. Consequently, banks burdened by defaults couldn’t pay their investors, which led to a loss of confidence in the financial system. In contrast, lending guidelines are stricter now, and the high interest rate was implemented precisely so banks have the funds to pay debts without being burdened like they were in 2008. The current increase in prices that we are seeing, across all industries, not just real estate, is driven to a greater extent by market forces such as international post-pandemic economic recovery, inflation, and a shortage of imported resources like natural gas and oil due to global conflict.

Why you shouldn't waive an inspection even in a competitive market

All that said, if you’re determined to not let high interest rates get in the way of your decision to buy, it’s even more imperative to secure your investment with a property inspection before closing any deal. Take the time to book a qualified inspector to view your property and make sure it isn’t hiding any costly secrets like a water heater that needs to be replaced, or a septic system on the brink of ruin. Due diligence now can save you money and headache down the road.

In the fast-paced housing market that preceded this latest slowdown, we saw many buyers waive their right to an inspection in order to stay competitive. But now is not the time to forgo the inspection. Booking with Inspectify streamlines the often lengthy process of finding a qualified inspector, booking the property inspection, and receiving the report. We can provide a comprehensive report from a professional inspector within a week of booking, or even sooner. We even include free repair estimates in our reports! And because the inspector writes their findings directly in the Inspectify app, the report is ready for you to read once the inspection is complete.