What Happens to Home Prices as Interest Rates Rise?
Welcome to The Sunday Morning Post. Subscribe below to get content in your inbox each Sunday morning. Thanks for being here.
All the talk in the housing market over the past year has been about whether the sharp increase in home prices will continue. Now that interest rates are rising, the question is in greater focus. I am on the record from August 2021 and January 2022 as saying I do not believe we are in a housing bubble and my thoughts remain basically unchanged: pent-up demand from buyers is just so strong, there is a serious lack of inventory, a generation of potential homebuyers is coming of age, and the state of the home-buying U.S. consumer is, in fact, relatively strong.
One variable that has changed, however, is that interest rates have risen pretty significantly in the past few weeks. The quick pace of rate increases has surprised even me as I had been forecasting slower and steadier increases over a longer period of time. But what has actually happened is that banks are already pricing in the anticipation of future rate increases and the yield on the average 30-year fixed rate mortgage nationwide topped 5.00% this past week after being at just over 3.00% at the start of the year.
So is the party over? Not exactly.
What the Data Tells Us
In researching things over the past couple of weeks, I have found five examples in the past fifty years of interest rates in the United States rising significantly over a relatively short period of time. In only one of the five examples did home prices drop from the start of the time period to the end. And in only one example out of five (a different example, in fact) were home prices lower 12 months after the interest-rate peak than they were at the interest rate peak. In other words, despite rising interest rates, home prices mostly continued to increase as well and there was also generally no delayed impact effect of home prices dropping in the months after interest rates peaked.
Here is the data:
From September 2017 to October 2018, the average yield on a 30-year fixed rate mortgage increased from 3.78% to 4.85%. Home prices during this time increased 3.24% from a median price of $320,500 to $330,900. Twelve months later the median home price was $318,400, down a modest 0.66% from the initial period and down 3.78% from the peak in interest rates 12-months prior.
From May 2013 to September 2013, the average yield on a 30-year fixed rate mortgage increased from 3.35% to 4.57%. Home prices during this time declined by 1.23% from a median price of $268,100 to $264,800. Twelve months later, however, the median home price was $281,000, up 4.81% from the initial period and up 6.12% from the peak in interest rates 12-months prior.
From October 1993 to December 1994, the average yield on a 30-year fixed rate mortgage increased from 6.74% to 9.25%. Home prices during this time increased by 3.94% from a median price of $127,000 to $132,000. Twelve months later the median home price was $138,000, up 8.66% from the initial period and up 4.55% from the peak in interest rates 12-months prior.
From July 1980 to October 1981, the average yield on a 30-year fixed rate mortgage increased from 12.23% to 18.53%. Home prices during this time increased by 6.63% from a median price of $64,900 to $69,200. Twelve months later the median home price was $69,300, up 6.63% from the initial period and up 0.14% from the peak in interest rates 12-months prior (more on this 12-month period of time below, however).
From February 1977 to April 1980, the average yield on a 30-year fixed rate mortgage increased from 8.65 to 16.35%. Home prices during this time increased by 37.58% from a median price of $46,300 to $63,700. Twelve months later the median home price was $66,800, up 44.28% from the initial period and up 4.87% from the peak in interest rates 12-months prior.
In summary, in four out of five examples, home prices increased even as interest rates rose. In four out of five examples, home prices were still higher 12-months after the peak in interest rates, which shows that there was also not a significant delayed impact effect on home prices due to the rising rates.
When Home Prices Fall
So what does cause home prices to fall? There are a number of variables, but generally speaking home prices tend to drop when the U.S. economy goes into a recession. In fact, in researching this question I found five examples of home prices decreasing in the United States over a short period of time. The United States was in an economic recession in all five cases:
Quarter 1 of 2020 to Quarter 2 of 2020 (the outset of COVID-19): the median home price dropped 1.9% from $329,000 to $322,600.
Quarter 1 of 2007 to Quarter 1 of 2009: the median home price dropped 19.04% from $257,400 to $208,400.
Quarter 2 of 2001 to Quarter 4 of 2001 (a period of time that included September 11th): the median home price dropped 4.41% from $179,000 to $171,100
Quarter 2 of 1990 to Quarter 3 of 1990: the median home price dropped 7.73% from $126,800 to $117,000
Quarter 4 of 1981 to Quarter 1 of 1982: the median home price dropped 5.68% from $70,400 to $66,400.
With the possible exception of the 1981-1982 drop in prices, it is fair to say that a rise in interest rates was not a cause for the United States slipping into recession. In fact, in all of these examples other than the 1981-1982 example, interest rates were mostly dropping in the months leading up to these declines in home prices.
One final thing to note that I found to be particularly interesting when doing this research: in all five of the examples above of periods of time when U.S. home prices declined, home prices were actually higher 12 months later every single time:
In Q1 1983, prices had rebounded 10.39% from the low point Q1 1982
In Q3 1991, prices had rebounded 2.56% from the low point in Q3 1990
In Q4 2002, prices had rebounded 11.10% from the low point in Q4 2001
In Q1 2010, prices had rebounded 6.96% from the low point in Q1 2009
In Q2 2021, prices had rebounded a whopping 18.60% from the low point in Q2 2020
A Note about 1981
Sharp-eyed readers will note above that home prices did not drop from July 1980 to October 1981 even as interest rates surged, plus home prices were still higher, albeit modestly so, one year later in October 1982. However, home prices did drop in the short time from Q4 1981 to Q1 1982 by 5.68%, which was likely at least partially interest-rate driven as the average rate on a 30-year fixed mortgage peaked at 18.53% just prior to the drop in October 1981. However, prices then rebounded so fast the drop did not really get captured in the data at least by the time metrics I am using for this analysis. I wanted to make this note, however, to acknowledge that, yes, home prices did drop during this period, but then quickly recovered. This was also a period of time that the U.S. economy was in recession, a particularly unique time in U.S. economic history as the recession was actually induced by the Federal Reserve hiking interest rates in order to reign in inflation. So needless to say, there was a lot going on during this time period. To summarize briefly, interest rates spiked significantly, home prices did drop likely through a combination of high rates and the interest-rate inducted recession, but then home prices did rebound (and then fairly steadily increased for the rest of the decade).
What Happens Next
So what all of this speaks to, I think, is that home values are fairly resilient. Even in periods of time when home prices are dropping, once they are through the trough home values tend to head back in the positive direction in relatively short time. A home, especially a personal residence, continues to be a very good long-term investment, which makes it all the more problematic that so many first-time homebuyers and others are having so much trouble getting into the home-buying market today (a topic for another article).
As for today, the meteoric rise in home prices over the past two years does distinguish this time period a bit from previous ones, and it is natural to assume that prices will drop. There are also some clear comparisons between today’s high-inflation landscape and the early 1980s, a time in which interest rates surged as the Fed tried to reign in red hot inflation.
My take on this is that prices will only drop if the United States experiences a significant economic recession. As I wrote about recently, I do think the United States is likely to enter a modest recession in the next two years, but I also think other economic indicators are so strong (including demand for homes) that the recession will be mild. I do not foresee a significant drop in home prices, although as I said in my housing market previous for 2022, I think it is also fair to expect that the rate of increase in home prices will ease. In other words, I see home prices continuing to rise, but the rate of increase will slow down. I still do not see a bubble.
If you are receiving this article as part of my weekly emails, you are already subscribed. If you are reading it because you saw it online or someone forwarded it to you, make sure you are subscribed below (for free) to get my analysis and research each week.
Ben Sprague lives and works in Bangor, Maine as a V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram.
Author’s Notes on Methodology…
Data on interest rates is based on a publicly available dataset from FRED/St. Louis Federal Reserve.
Data on median home prices is also based on data from the same source.
Data on interest rates is based on average monthly rates. Data on median home prices is based on average quarterly prices. There may be some modest inaccuracies when blending monthly and quarterly data, but for the purpose of this article it is believed that the data is “good enough.”
Weekly Round-Up
Here are five things that caught my eye around the web this week that I thought you should know about too:
From Dana Anderson at RedFin, a record high 32.9% of homebuyers are looking to relocate, including many from America’s largest cities and techcenters.
A group of researchers found that using discretionary income to “buy time” in the form of time-saving devices or services increases happiness more than buying material items. They say:
Around the world, increases in wealth have produced an unintended consequence: a rising sense of time scarcity. We provide evidence that using money to buy time can provide a buffer against this time famine, thereby promoting happiness…
…Feelings of time stress are in turn linked to lower well-being, including reduced happiness, increased anxiety, and insomnia. Time stress is also a critical factor underlying rising rates of obesity: lacking time is a primary reason that people report failing to eat healthy foods or exercise regularly.
The NFT market, so hot just a few months ago, seems to have imploded. Per The Guardian, “Man who paid $2.9m for NFT of Jack Dorsey’s first tweet set to lose almost $2.9m,” which is an objectively funny headline.
From Chris Morris in Fortune, house flipping is at a 15-year high, but because of the rising costs and supply chain issues, profits were at a decade-long low. From the article, the average flip takes 153 days and the average profit is $65,000, but with a wide range among various markets.
Check out this bird playing with a ball:
Have a great week, everybody.