Rising Mortgage Rates Impact on Home Prices

Something that has caught my attention and really got me thinking lately is that from May 2nd to August 2nd there has been roughly a 100 basis point move in mortgage rates. Having traded fixed income securities institutionally for over 10 years now, needless to say a spike like that in interest rates is far from the norm, but then again we don't exactly live in normal times.

I know there is strong evidence backing up the thesis that the correlation between home prices and mortgage rates is not very strong. Even when you look at it from an inflation adjusted perspective, history still points to the fact that rising mortgage rates doesn't inversely affect home prices. Now in theory, just by using a basic rule of thumb that for every 100 basis point move north in rates it can negatively affect a home buyer’s purchasing power by 10%, you'd assume by decreasing a groups buying power prices would likely have to follow to offset that gap in the market. However, historically from most the data that has been gathered, that has not been the case, and I believe the reason for that is twofold.

First, in the past where most correlation statistics has been collected, interest rates moved more organically with the overall economy. What I mean by that, is when the economy was getting stronger it would normally pull rates up along with it, so in terms of housing prices, any rising mortgage costs were likely negated by higher wages and consumer confidence. Secondly, in times of heightened inflation, an asset class like real estate benefited greatly and acted like a hedge of sorts, once again offsetting rising mortgage rates potential for downward pressure on home prices.

Unfortunately, as I had mentioned earlier, we tend to not live in traditionally normal times anymore. As Bill Gross, the famous CIO of PIMCO once deemed this; we live in a "new normal". In that new normal the Federal Reserve has taken unprecedented measures to keep interest rates artificially low to help stimulate a very stagnant economy. By flooding the system with liquidity you see the effect it has had in risk assets such as the stock market - currently at all time highs. Now re-visiting that recent 100 basis point move in mortgage rates, this was essentially manifested by Fed Chairman Bernake simply whispering in the wind “the potential tapering off of Quantitative Easing” - and with that the bond market had a heart attack. Let me be clear here, no policy changed at all, just the bond markets assumption that soon it might – and that fear alone added 100 basis points in mortgages.

With that being said, my general thesis is basically that interest rates have been a major driver in this housing recovery and need to be examined in a different context than what they have been historically. For instance, as a real estate investor looking to rehab and flip properties - it is worrisome to me that over the course of improving my property mortgage rates could drastically spike quite quickly, potentially affecting my target markets buying power and possibly eating significantly into any expected returns I had forecast.

So I’m really very interested and looking forward to others perceptions and opinions on here. Obviously markets react differently based upon price points and so forth, so I’d love to hear different experiences and insights. Thanks for taking the time to read this!