Rapidly Changing Real Estate: The Fed’s big move and a peak at future home prices
The state of the housing market and the economy is at a pivotal moment with an uncertain path forward. The Federal Reserve just increased the federal funds rate target by 50 basis points (.5%) with further more expected rate hikes in 2022, impacting nearly everything -home prices, stocks, loans, and more.
Why does this have such a profound impact on markets, particularly the housing market?
Exploring the Federal Reserve
What is the Federal Reserve?
In short, the Federal Reserve is the central bank of the government. It is the “bank of banks”. It is an independent party to the current government administration with its own sets of rights and powers with a mandate “to influence the availability and cost of money and credit to help promote national economic goals.” (Source: the Federal Reserve)
Who is on the Federal Reserve ( “the Fed” )?
There are multiple committees that make up the Federal Reserve’s key policy makers: The Board of Governors, the Federal Reserve Branch Banks, and the Federal Reserve Open Market Committee.
1. The Board of Governors: The Board consists of seven appointed individuals who answer to congress and the government on policy making decisions. Their job is to analyze the economy and work on making policy decisions to meet the mandates mentioned above.
2. The Federal Reserve Banks: Twelve individual federal banks which are separated by region and which comprise the twelve districts of the United States. This was created to decentralize the country and to help give regionality to the Fed’s decisions based on prevailing trade regions.
3. The Federal Open Market Committee: The committee which is comprised of the Board of Governors and the regional Federal Reserve Bank chairs that makes policy decisions.
The decision makers or voting members on this committee change slightly year over year, because the voting members are the seven members of the Board of Governors, Federal Reserve Bank of New York Chairperson, and four other Federal Reserve Bank Chairs of the remaining eleven Federal Reserve Banks which rotate every year.
See the list of current officials
What is the Federal Funds Rate?
The Federal Funds Rate (FFR) is the average interest rate that banks pay for overnight borrowing from the federal reserve to meet their reserve requirements. These reserve requirements, which are also set by the Federal reserve, are mandated amounts that banks must keep in reserve in the case of consumer withdrawals, etc. The federal funds rate is effectively what banks borrow or lend money to other banks at when they are short or have excess funds in their reserve accounts.
Since Banks are in the business of making money by making loans, they typically loan at a higher rate than they would borrow from and make the difference. Therefore, if the FFR rises or lowers, then banks typically move the rates that they pass onto consumers and businesses in sync with these rates. This increases or decreases the cost of borrowing, which further affects investment, growth, employment, and inflation in the economy. Therefore, changes to the FFR are extremely important because it can cast a ripple effect which directly affects the trajectory of the economy.
The FOMC Tools
The Federal Reserve’s tools for affecting monetary policy:
- Changing the Discount Rate, IORB Rate, and ONRRP rate
- Changing money supply through open market purchases
- Changing the reserve requirements for member banks
IORB Rate – The Interest on Reserve Balances (IORB) is the rate that the Fed gives banks on funds that they deposit in reserve with the Fed. This is typically only eligible for larger banks with accounts at the federal reserve.
ON RRP Rate – The Overnight Reverse Repurchases (ON RRP) is a program where the Fed sells securities to other institutions who aren’t eligible for the IORB rate and buys them back the next day at a slight premium. This effectively acts as an interest rate floor.
Discount Rate (Discount Window) – The Discount rate is the rate that the federal reserve would lend to banks, which is typically much higher than where the target federal funds rate is. In the event there is no more funding available for the required reserves in the open market, this effectively acts as a ceiling on the borrowing rate by the Fed.
Why the Federal Funds rate is important
The federal funds rate is important because it has lasting effects on the growth of our economy and affects large and small businesses alike. When the Federal reserve changes the federal funds rate, it creates a ripple effect that has secondary, tertiary, and further effects in the market.
Example:
Fed Action: The federal reserve raises interest rates target by 50 basis points (0.5%).
Secondary effect: Increased market rates/borrowing costs for banks and the federal funds rates moves up in line with policy measures.
Tertiary effect: Higher borrowing costs (mortgages, credit cards, business loans, etc.), slowing down lending and investment by businesses and consumers in the economy.
Quaternary effects: Higher borrowing costs and lower spending by businesses and households due to higher rates, causing lower demand, employment, and lower prices.
Possible Effects on the Housing Market
There are two cases we explore, the case for a low supply/low demand market and the case for a high supply/low demand market.
Case 1: The Expected Case
Low Supply, Low Demand, and Higher/Flat Prices
(Transition to a Balanced Market)
The case for a low demand/low supply market has become the de facto forecast for the residential real estate market. In this case, home prices are expected to continue to rise as inflation and supply chains issues continue. It will then begin to decelerate and have a “soft landing” where prices will begin to level out as interest rates continue to rise, but home supply remains low. There are a number of indicators which point to this including a well-capitalized consumer, material shortages, and increasing interest rates, to name a few.
Lower Demand
Mortgage rates have reached their current levels in a hurry topping 5% – the highest rates seen since 2018. This will inevitably lower demand as buyers are forced out of the market for homes due to lack of affordability.
Low Supply
Home supply is expected to also remain low due to a number of factors such as:
1. Locked in interest rates by homeowners: When homeowners have locked in historic lows on re-finances, they don’t want to sell and get a new higher rate.
2. Stronger consumer balance sheet: Strong consumer and homeowner balance sheets (source: The Federal Reserve)
3. Slowed new home construction due to material shortages: Shortages due to supply chains as a result of COVID-19, increased nationalism, and the war in Ukraine
4. Remote work trends (i.e. work from home): Not a rush to sell and move because work is more flexible
5. A perceived continuing rise in home prices: Expected continued spike in prices is keeping many homes on the sidelines because they want to make more money on their investment (i.e. Why sell now when there is still upside?)
Household Debt Charts by the New York Federal Reserve
Case 2: The Unexpected Case
High Supply, Low Demand, and Lower Prices
(A Quick Transition to a Buyer’s Market)
There is, however, another scenario where things could result in home price drops (and potentially in a hurry). In the event of a prolonged recession or high inflationary period, which could very well happen, there is an argument where excessive risk taking, over-levered consumers, and an increased productivity/supply in building homes (3-D printing homes) where the supply could increase dramatically as consumers “rush for the door” to sell their properties. This increased supply in combination with a continued low demand, would create a drop in prices as a supply/demand imbalance grows. A scenario like this likely wouldn’t happen for some time (or could not happen at all), but there are indicators to look out for which may point to a future high home supply market.
High Supply
In the event of a prolonged recession or stagflationary environment, where employment falls and prices of goods continue to remain high for an extended period of time, the supply of homes could quickly begin to increase as the proliferation of 3-D printed homes and the financial squeeze on consumers begins to stake effect on homeowners.
1. Over-levered Consumers – The Two Income Trap
In times of a recession or contractionary economic policy, employment typically falls as investment, lending, and growth slows. If many households are over-levered and cannot afford to positively cover their payments, they may be forced to sell their homes and put it on the market to create liquidity, thereby increasing the supply of the homes on the market.
The two-income trap was an examination of the causes of increasing personal bankruptcy rates and economic insecurity among American Households, particularly the middle class. It explores why two-income familes are in more precarious situations that one-income households because the household takes out larger loans based on both of the parent’s incomes (i.e. people borrow to the maximum amount that they are able to). This over-leverage puts a higher strain on the two-income families in times of distress, typically when one or both of the income producing family members lose their job. This could also happen if the cost of goods increase faster than their wages do (i.e. high inflationary periods).
2. Increased Consumer Risk-taking
As the Fed (mentioned above), expanded monetary policy prior to where we are today, they also lowered the reserve requirements for banks by increasing the threshold for banks who require only low reserves or no reserves. This lowers the required federal funds held by smaller banks, allowing them to continue lending out in the marketplace without the heightened effects of an increase in federal funds rates.
As a result, this may allow some banks to lend more non-conventional loans, which can be a good thing, but can also lead to excessive risk-taking by consumers.
In order to buy homes today and make the payments work, some homeowners are also locking into short term loans such as a 5 year adjustable rate mortgages (ARMs), where the loan is fixed at a lower rate for five years and then it moves to an adjustable rate at afterwards. This “stretching” to buy a home may only further cause consumers to be over-levered and fall into similar situations as the Two Income Trap mentioned above.
3. New Technology: 3-D Printed Homes
It’s unclear how the advent of 3-D Printed homes will affect the market. Will it be viewed as a second-tier product? Will the technology advance enough to where it can be as customizable and unique as homes are now? I’ll cover these topics about 3-D Printed Homes in a later article, but the advent of 3-D printed homes will certainly cause a rapid increase the number of homes available in the marketplace by increasing productivity and the speed of construction. This is another reason why, in the next few years, you could see a large increase in the home supply.
4. Easing Supply Chains & Better Global Relations
If tensions around the world begin to ease and supply chains begin to work themselves out, you could see a sped up supply chain where developers continue to produce houses at a faster rate than today and where building costs drop, causing more houses at a lower price point to enter the market.
5. Excessive Building – A Whiplash Effect
We have a tendency to overdue things when forecasts look good, creating a whiplash effect due to overindulgence. There could be an excess of development because builders and developers see prices continuing to rise, so they continue to build at an increasingly rapid clip to make more money more quickly.
Summary
It’s unclear how the market trajectory for home sales will move in the next year or two largely because it depends on Fed policy, trade/supply chains in the global economy, and new technologies entering the marketplace. While a slowing demand seems obvious, determining the effects and trajectory on housing supply can be a bit trickier to navigate. Where do you think the market will go?
If you’re currently in the market for a new home or you’re trying to sell your home in the Houston area, you’ll want to work with a real estate agent in Houston who knows the local market. Parceto Real Estate is exactly that.
The information and details contained herein have been obtained from third-party sources believed to be reliable, however, Parceto Real Estate has not independently verified its accuracy. Parceto Real Estate, it’s owners, stakeholders, and employees make no representations, guarantees, or express or implied warranties of any kind regarding the accuracy or completeness of information and details provided herein, including, but not limited to, the implied warranty of suitability and fitness for a particular purpose. Interested parties should perform their own due diligence regarding the accuracy of the information.
Any information provided herein, is being provided subject to errors, omissions, changes of price or conditions, and withdrawal without notice. Third-party data sources used in this article include: The Houston Association of Realtors and Freddie Mac. All content is provided on an “as is” basis, with no warranties of any kind whatsoever.
You should always consult with the assistance of an appropriate professional before making any decision. Opinions, estimates, forecasts, or other views contained in this document are those of Parceto Real Estate, and no information referenced in the article should be considered investment advice.
© 2022 Parceto LLC, d.b.a. Parceto Real Estate, all rights reserved. Third-party image sources: shutterstock.com, adobe.com
Online Information Sources:
The Federal Reserve, “Federal Open Market Committee.” FederalReserve.gov, 06 Apr, 2022, https://www.federalreserve.gov/monetarypolicy/fomc.htm#:~:text=The%20Federal%20Open%20Market%20Committee%20(FOMC)%20consists%20of%20twelve%20members,terms%20on%20a%20rotating%20basis.
The Federal Reserve, “Structure of the Federal Reserve System.” FederalReserve.gov, 10 Sep, 2021, https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-system.htm
The Federal Reserve Bank of St. Louis, “How the Federal Reserve Implements Monetary Policy.” Stlouisfed.org, https://www.stlouisfed.org/education/monetary-policy-lecture-guide
The Federal Reserve Bank of New York, “Household Debt and Credit Report (Q4 2021).” Newyorkfed.org, https://www.newyorkfed.org/microeconomics/hhdc
The Houston Association of Realtors, “Houston Housing Affordability Declines with Soaring Prices.” Har.com, 03 May, 2022, https://www.har.com/content/newsroom?pid=1857
Wikipedia, “The Two-Income Trap” wikipedia.org, 05 Dec 2021, https://en.wikipedia.org/wiki/The_Two-Income_Trap
The Federal Reserve, “Policy Tools (Reserve Requirements).” FederalReserve.gov, 04 Jan 2022, https://www.federalreserve.gov/monetarypolicy/reservereq.htm
ICON – 3D Tech, “3-D printed Homes by ICON | Austin, TX | Developer 3Strands” youtube.com, 31 Aug 2021, https://www.youtube.com/watch?v=IRYjZed8ysM
The Federal Reserve, “Balance Sheet of Households and Nonprofit Organizations, 1952-2021”, FederalReserve.gov, 10 Mar 2022, https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/table/
Yahoo.com, “Zillow: Our 2022 housing forecast is way off – home prices now set to spike 16%”, yahoo.com, 07 Feb 2022, https://www.yahoo.com/video/zillow-2022-housing-forecast-way-093355186.html
