Interest rates are going up … and that’s a good thing.

The Federal Reserve has signaled a change in its guidance.  It is likely to taper bond-buying and move up its timetable for raising rates.  I have never accepted the Federal Reserve’s position that inflation is “transitory”.   For months I have advanced on these pages that the unrelenting run-up in home prices is not healthy.  The only thing that will cool the rate of appreciation is an increase in mortgage interest rates to a range of 4.5%.  Thankfully, over the past 2 weeks the yield on the 10-year Treasury has finally begun to move up, with mortgage rates following suit.

Recently I was invited to a presentation by Marci Rossell, Chief Economist of our company’s global affiliated network, Leading Real Estate Companies of the World.  Rossell painted a rearview and forward-looking economic outlook.  As I have opined on these pages for months, and Rossell reaffirmed, this is not a housing bubble.  A housing bubble occurs when people buy because they think prices are going up.  That is not why they are buying.  The rapid run-up in home prices is need based, due to surging numbers of buyers far outstripping the supply of homes for sale.  The combination of the largest demographic group ever, Millennials, together with Gen Xers and Baby Boomers, historically low interest rates, insufficient new housing product, continued COVID related trepidation by sellers to list their home, and geographic/occupation/lifestyle relocations from the pandemic have collectively contributed to the greatest shortage of resales and new homes for at least the past 50 years.

Rossell explained in economic/social terms how the pandemic severed people not just from their jobs and occupations, but geographically.  During the dark days of the 2008 Great Recession, the Federal Government spent $800 billion.   To date, in 2021, the Federal Government has spent $6.5 trillion. Put that in perspective.  And the purpose?  To stop the pain.  But in doing so it overcompensated people.  The degree of government support is onerous, and the cost will be incurred for years.

In a typical recession wealth, principally stocks, bonds and real estate go down, not up.    There is no financial crisis when wealth goes up.  In 2020 global wealth increased $28.7 trillion (the entire US economy is $27 trillion), to a value of $418.3 trillion, principally in real estate and stocks. 

The term “Wealth Effect” stands for the proposition that for every $1.00 your wealth increases, you spend 0.5 cents.  As restrictions ease, the value of assets and savings go up, consumers renovate their homes and spend on durable goods.  Any disruption to the supply chain has a rippling effect.  As the pandemic eased, demand snapped back and there was, as Rossell called it, a fireworks explosion.  Fireworks come with noise.  That noise we’re hearing is inflation.  We are all experiencing it at the cash register.

The Federal Reserve does not care about isolated events, including an isolated pandemic.  It cares about the long-term market.  The labor market is in a demographic squeeze.  The pandemic has escalated retirement.   An extra 1.3 million people retired beyond what experts projected due, as cited above, to the increased value of real estate and stock portfolios.  Currently, the deficit is 16.7% of Gross Domestic Product (“GDP”).  According to Rossell, a deficit of 5% relative to GDP is sustainable, and until long-term interest rates rise to 4-5%, politicians will not do anything about the debt, we will continue to run increasing deficits.

According to the 2021 National Association of Realtors Home Buyer and Seller Generational Trends Report, Millennials, 22 to 40 years, account for 37% of all homebuyers, are the most educated age group, and are entering their prime home buying years.  Millennials will drive homebuying for many years, providing a steady replenishment of new buyers.

Buyers 41 to 55 are Gen Xers, consisting of 24% of home buyers.  61% have children under the age of 18.  18% were most likely to purchase a multi-generational home. They are purchasing the second most expensive homes and the largest homes. 

Baby Boomers, 56 to 74 years, represent 32% of home buyers.  Their influence upon the economy and society will continue to be impactful for years to come, especially in our Sarasota County retiree market.  Baby Boomers purchase for an array of reasons, whether to own a home of their own, the desire to be closer to friends and family, and/or to live in a better place.  Baby Boomers are expected to own their homes for 20 years.

According to Trendgraphix (see tables below), in September the median sold price of single-family resales in Sarasota County jumped 30% from last year at this time to $403,000.  Average days on the market, 21 days.  Inventory based on pended sales was 0.7 months, i.e., a 3-week supply; 0.8 months for inventory based on closed sales.  Algorithmically, without any new listings, in less than 1 month there would be no resales available for sale. 

Notwithstanding all the new communities sprouting all over our area, there remains a shortage of new homes.  It’s been that way, nationwide, since the early 1970s.  The median sold price for new homes in Sarasota County was $401,000 in September 2021 vs. $345,000 in September 2020.  New homes sold at 100% of list price, and there was a 2.5-month supply based on pended sales.  Due to supply chain disruptions, labor shortages and inflationary pressures, costs to build continue to rise.  It generally takes 7 – 12 months to build a home.  Consequently, builders are slowly releasing homesites and often with competitive bids to control production, costs, meet contractual times for performance, and maintain profit margins. Even when and as the market cools, builders will continue to release lots in a slow drip campaign to maintain continuing demand for new housing, bolster prices and support profits.

Black Knight, a real estate and mortgage analytics company reported in September that 3.9% has been the 25- year average price appreciation rate.  Since the first of the year through September 30, all single-family homes have appreciated 18.2%.  The market remains hyper-hot, homes commonly selling with multiple bids and over list price.  Many buyers, frustrated, have moved to the sidelines.  The market is screaming for some normality. It is why I have argued since the summer that we need mortgage rates to move up to the mid 4% range, although still historically low, it should be enough to cool but not deflate the rate of appreciation to single digits.  Historical evidence is on my side.  It has happened twice before in the past decade, 2013/2014, and 2018/2019.

The yield on the 10-year Treasury is a key benchmark for mortgage rates.  Mortgage rates customarily run just under 2X the yield on the 10-year Treasury.   It is the reason I have argued for months that I hope to see the yield close out the year at 1.75%, if not higher, and by mid-year 2022, rise to 2.5% range.  Excepting this past March 19, 2021, when the yield temporarily spiked to 1.74%, the yield has been hovering around 1.3%, and mortgage rates have been amongst the lowest ever, in the mid to high 2% range.  With inflationary pressure building, over the past 2 weeks the 10- year yield has risen.  It closed this past Friday, October 15^th at 1.74%.   Mortgage rates have followed suit, currently around 3.2%, its highest point since April of this year. 

As we approach the end of the year, here is my wish for 2022:  May the yield on the 10-year Treasury reach 2.5%, and mortgage rates 4.5%.  It will be a good thing.  Sustainable appreciation.  Good for sellers.  Good for buyers.  Good for housing.