The Federal Reserve recently announced a 0.75% increase in its benchmark interest rate, which is set to worsen an already bad housing situation.
Rising rates will cause interest rates on fixed-term and variable-rate mortgages to rise, affecting the ability of potential buyers to pursue them while causing builders to cut production of new homes, experts say. . The overall cost of housing could come down, but with less supply and increasingly common cash buyers, more people will be pushed out of the housing market.
“We are not optimistic that increases in the federal funds rate will thwart the rapidly deteriorating affordability, homeownership and fundamental housing shortage facing the country,” says Mike Kingsella, CEO of nonprofit advocacy group Up For Growth.
Housing supply is already well below demand. A recent report by Up For Growth reveals that there is a shortfall of nearly 4 million homes in annual housing production. This figure represents the mismatch of supply and demand from 2019, the most recent year for which data is available. This is an underproduction problem that has only worsened over time, having more than doubled from the 1.6 million housing deficit in 2012. The impact of the pandemic on supply chains and the cost of building materials has likely further constrained supply in recent years, and rising interest rates will likely constrain it even more.
Kingsella says the situation today is very different from just a few years ago, when interest rates were low and the cost of labor and materials was not not prohibitive for manufacturers. Since most homebuilders in the United States are small businesses, higher interest rates and material costs affected by the pandemic will likely deter them from investing in new projects.
“If we were 3.8 million houses short of meeting housing needs at best, imagine how far we would fall as interest rates rise, and it will become even more difficult for homebuilders essential to access loans to produce this product,” he says.
It will also have a ripple effect on tenants, according to Diane Yentel, president and CEO of the National Low Income Housing Coalition. “Rising mortgage rates mean fewer home sales and fewer potential first-time home buyers, which increases rental demand,” she says. “Increasing demand and decreasing supply is driving the skyrocketing rents we’re seeing across the country.”
For potential homebuyers on the lower end of the income spectrum, rising rates could turn out to be a good thing, according to Bruce Marks. He is the CEO of the Neighborhood Assistance Corporation of America, a nonprofit homeownership advocacy organization that also offers mortgages at below-market interest rates.
“Sometimes lower rates lead to higher house prices,” Marks says, because more people can access loans more easily, which increases competition and the price of what’s on the market. “With higher rates, the result is lower house prices.” With below-market mortgages offered by groups like NACA, low-income homebuyers may still be able to enter the market with less competition, but that remains to be seen.
“At this point we see it as a washout, but it could be a net benefit,” adds Marks.
But Marks and Kingsella say there are still systemic problems in the housing market that will persist despite this rise in interest rates.
On the housing supply side, Marks says the biggest challenge is the aggressive buying power of private capital and hedge funds buying large amounts of single-family homes and turning them into rental properties. It’s a problem the country is unlikely to get out of, he argues. “Even in the best-case scenario, the amount we build will be almost totally discounted by these cash buyers,” he says. “You don’t see the government – federal, state or local – paying enough attention to this.”
Kingsella argues that more supply is needed, but slow-to-change land use policies are getting in the way. Until those policies change to facilitate building more, and at higher densities, he says incremental changes in monetary policy at the Federal Reserve might not be relevant. “Interest rates go up and down, timber prices go up and down, but zoning and land use are forever,” he says. “This is the main driver that has perpetuated and increased the severe housing shortage.”