What would today’s market news and punditry be without calls for a market crash? As yields on U.S. Treasuries began their meteoric rise over two years ago, calls for a crash in U.S. home prices were a dime a dozen. How could one not expect a crash after a 45% increase in home prices nationwide1 topped by 500 basis points in higher mortgage rates?
Most market prognosticators follow many markets; few dive into the weeds of housing. This has led to a simplistic formulation: Higher interest rates mean lower home prices – or the corollary, lower rates mean higher prices. This naïve theory treats housing prices as analogous to fixed-coupon bond prices, which move inversely with interest rates. The housing market, however, is not quite that straightforward. Forming an outlook on housing prices requires one dig deeper than single factors such as home prices and mortgage costs into the supply and demand dynamics.
While the resilience of housing prices surprised many observers during the two-year rise in mortgage rates into October 2023, I believe prices could soften in the future if borrowing costs fall to borrower behavior-changing levels. To explain this seeming paradox, I’ll review the unusual state of supply and demand in this illiquid asset class.
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