Let’s set the Table.

The Fed has raised its lending rate in an effort to stop runaway inflation. The cost of renting or owning- aka Housing- real estate is nearly 1/3 of the Consumer Price Index.

When the Fed raises its rates, mortgage rates tend to rise, too, even if they are not 100% correlated. More on that here.

And since 65% of Americans own their home, and nearly everyone would like to have a roof over their head, the cost of housing and the impact of Fed actions becomes the main focus. Even if tamping down the other 2/3 of the CPI is an even bigger part of the Fed’s mandate.

The US got very used to historically low mortgage rates. And now we have a reckoning at hand- even if mortgage rates are still half of what they were in the late 1970’s and early 1980’s.

As it relates to the real estate market, the questions people want answered are pretty clear. And the answers are, for the most part, straightforward, too. Where things go off the rails is when people look to ways to solve the problems facing the Real Estate market today.

Let’s discuss.

Are higher rates impacting sales market? If so, how?

The press is getting it mostly right. The WSJ understands the most basic part. Higher mortgage rates are keeping buyers away. And since they keep rising, we should see more of the same.

Why is there low inventory?

Low inventory is both a question and an answer. Sales volume is also down because there’s nothing to buy in many cases.

And the explanation for low inventory is this: Sellers are scared to put their homes on the market for fear of getting lower prices, not being able to sell at all or both. Sellers are also reluctant to sell because they have a low mortgage rate that they love. And so they are frozen, if they want to upsize or downsize- they the rate on a new home could be twice as high as their current mortgage. Some people are calling this Rate Lock, but that’s more confusing.

Home builders are struggling to keep up with demand for new construction. Homes are selling in bidding wars in markets all over the US. And 65% of all deals are all-cash in places like NYC.

Clearly the demand is there.

Are stable prices a good thing, or a bad thing?

Presently, low inventory is helping to keep home prices stable.

If the idea is to stop inflation, flat sales prices would, in theory, be satisfying the mandate. Except that the CPI doesn’t measure housing prices. It measures the cost of housing for consumers each month. And as rates rise, that cost goes UP for new homebuyers. Someone please correct me, but it seems that the Fed is indirectly creating inflation in this regard. And unless prices drop for houses, the costs will only drop when rates do.

What Are the Solutions?

Is there some grand conclusions to tamp inflation? Are there ideas about how to make the real estate market healthier?

There have been some ideas worth exploring. But most are wrongheaded:

Raise the Fed rate Some More

Hmm…it seems that if the Fed wants to send the economy into recession, the quickest way to do this is via a recession. But we haven’t had one yet with a doubling or rates in the past 12-18 months. One could argue that continuing to raise rates won’t do it, either. But do we really want to find out?

Reduce mortgage rates back to where they were in 2016-2022.

First, this isn’t happening. Second, rates were kept too low for too long, and that drove the inflation over the edge.

Eliminate the 30-year mortgage

This New York Times opinion piece this past weekend tries to pin inflation of the other 2/3 of consumer goods on mortgage rates. Somehow, low mortgage rates gives consumers too much discretionary money to overspend on everything else. Fixed mortgage destabilize the banking system. And in a world in which homeowners can use their home’s 30 year mortgage as a forced savings plan, somehow having a lower mortgage is a bad thing. Later in the article it admits that adjustable rate mortgages prove even harder for consumers to manage than refinancing. But you should read this one yourself. I found myself yelling at the computer. If you believe that home ownership is important, then the 30-year fixed mortgage will be a part of the American Dream for some time to come.

Let’s not forget that investment properties are plummeting in value, because no one can make money in the current mortgage rate environment. So the Fed has already done its job in this regard. Well done. The investment market is only functioning where sellers are distressed.

Remove the mortgage interest deduction caps

This gets a little esoteric but follow me. State and Local Income Tax deductions against federal tax payments was capped in 2017. And in high tax areas like New York City and its surrounds, this has been a real backbreaker in terms of the discretionery funds New Yorkers have at their disposal.

What the IRS has found is that many small businesses found a workaround to continue to get state and local income tax deductions anyway.

But what about mortgage interest deduction caps? This would give new buyers more incentives to purchase, even in a higher mortgage rate environment. And as rates go down in the coming 12-24 months, those deductions would likely shrink, anyway.

One Last Suggestion – How About We Give Americans A Little Break?

I was watching the Today Show this morning. Eggs are cheaper today. Milk is cheaper, too. And oranges? Also less expensive. So inflation is coming down in places.

Sure, apple prices are up. As is cereal. So maybe it’s time to switch up your breakfast.

More importantly, would it be nice to find a happy medium on the cost of housing?

Why not try to lower the Fed rate a tiny bit, therefore reducing mortgage rates? I think this is the mostly likely solution. The question is just how long will it take the Fed to wake up and make some incremental moves in the other direction. Let’s hope it’s before any real shudders to the financial markets. -S