The Fed’s gambit is working. Increases in mortgage rates are bringing prices down for the short term in metro Atlanta, but longer term these increases will decrease supply at a time when the region is long on buyers and short on housing.
Freddie Mac estimates that the US is short 1.5 million homes due to the arrival of the millennial generation and their need for housing. By simple extrapolation, the metro Atlanta area is short some 30,000 homes.
Add to this the fact that Atlanta’s population is growing by 60,000 people per year, and one would expect the demand for housing in Atlanta to be very strong. It is. And that homebuilders are trying to churn out as many homes as possible. They are. And that all of this is supported by strong and increasing prices. It was.
Mortgage rates have increased at an unprecedented pace over the past six months from 3.5% to roughly 6.5% currently. Higher mortgage rates decrease housing prices by decreasing affordability:
- A 1% increase in the mortgage rate results in a 10% decrease in buying power.
In other words, a buyer with a $1 million budget at 3.5% mortgage rate can afford only a $700,000 house at a 6.5% mortgage rate. The mortgage payment is roughly the same for both. Buyers respond by moving down in price or out of the market.
But mortgage rates are a double-edged sword in the housing market. Many sellers are also buyers, and sellers follow the same pattern as buyers but at a slower rate. The latest statistics confirm this trend:
- Demand, as measured by showings per listing per FMLS®, is down 50% in Atlanta over the past 12 months.
- Supply (new listings per FMLS®) is down 20%.
Demand is decreasing more quickly than supply, which is what typically happens when the Fed raises interest rates. The shorthand measure of supply and demand is the inventory rate, which is listings divided by average monthly sales. Inventories, as expected, are therefore increasing.
- Inventories have increased by 80% over the past 12 months from 1.2 to 2.2 months of inventory.
Increasing inventories normally lead to decreasing prices, but this is where the mismatch between supply and demand in metro Atlanta intervenes:
- Home prices in greater Atlanta in December 2022 were 5% above their December 2021 levels and 9.5% below their June 2022 peak.
Two months of inventory is well below historical rates, which are closer to 5 months of inventory, and prices therefore have not declined dramatically. Sellers can be choosy, or could be, but with fewer buyers and increasing competition from other sellers, prices have declined from their peak.
In order to understand what will happen to prices in the future we need to consider the outlook for mortgage rates and inventories.
Whither Mortgage Rates?
The only thing investors know with certainty about the future now is that the Fed will continue to raise rates to fight inflation. This creates fear of a recession. Rising short-term rates and fear of a recession do not make for a healthy economic outlook or housing market. Current mortgage rates reflect this assessment.
Mortgage rates traditionally track the 10-year treasury rate, which is the bellwether of long-term rates. The difference between the two rates is called the spread. In times of uncertainty, the spread between the 10-year T-Bond rate and 30-year mortgage rates increases. The chart below depicts the history of this spread over the past twenty years. Note the current spike in the spread to three percentage points:
The 10-year T-bond rate is currently around 3.5% with mortgages around 6.5%. The current spread, 300 basis points (bp), is well above a more normal spread of 150-170 bp.
Mortgage lenders are now demanding a higher premium due to the increased fear of defaults and non-performance resulting from a potential recession. Note in the graph above that the other two peaks in the spread were in 2008, at the time of the great recession, and in 2019, at the time of COVID. At both times the spread fell only after the Fed began decreasing rates to fight the recession(s).
The Fed has been very clear in its commitment to stop inflation through higher interest rates. At least two more rounds of tightening are expected. Absent a clear signal of an improving economic outlook, the risk premium will remain.
- It is reasonable therefore to foresee mortgage rates remaining in their current 6% – 7% range through Q2 and perhaps through Q3 2023.
- The risk premium will dissipate, and mortgage rates decline, when the Fed signals an easier profile and/or the economic outlook clarifies.
- Mortgage rates are then expected to drop to a 5% – 6% range (assuming a 3.5% 10-year T-Bond rate).
Higher mortgage rates will continue to suppress demand, and supply will continue to outpace demand as new-construction homes come online and sellers needing cash put their homes on the market. However, the pace of the growth will be slow. A return to 5 months of inventory, the more normal position, is not foreseen in the near future.
The Bottom Line
The Atlanta housing market has been and should continue to be remarkably resilient given the mortgage increases of the past year. This reflects the fundamental mismatch between supply and demand in the greater Atlanta area. Mortgage rate increases have suppressed demand temporarily, but when rates begin to decline, then the floodgates of demand will reopen, and prices will return to and surpass their 2022 highs.
In the meantime, the outlook for the coming year is moderately bearish. All activity – buying, selling, and building – will slow. Inventories will continue to rise slowly, and prices will be more in line with 2021 pricing than with 2022, approximately a 5% decrease from 2022 highs for the greater Atlanta area. That said, the greater Atlanta area covers a very large geographical area, and individual sub-market areas can and will vary from this trend.