Thoughts

April 19, 2024 | 13:29

U.S. Housing Takes the Brunt of Fed Policy

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

U.S. home buyers can only wish the Fed was in more of a rush to reduce rates. While most sectors continue to show resiliency, the housing market isn’t one of them. After a solid start to the year when mortgage rates pulled back from 23-year highs, existing home sales fell 4.3% in March. A reversal in borrowing costs has kept affordability in the tank at the same time that other housing-related costs—insurance, taxes, maintenance—are soaring. Sales remain below year-ago levels and about 20% below long-run norms; this after 2023 marked an even worse year than the Great Recession.

Soft demand is taking the steam out of rising prices, which are still up nearly 5% in the past year due to a low supply of listings. While 30-year mortgage rates above 7% are curbing demand, it’s the sub-3% and 4% rates of two years ago that are choking supply by keeping owners locked into current loans and homes. Sellers might also be waiting for new rules on realtor fees to take effect in July which promise to reduce commissions, while buyers might be waiting to see if prices slip in response.

Weak demand isn’t lost on home builders. They started almost 15% fewer units in March than in February, holding below year-ago levels. Despite faster population growth, starts have fallen more than 20% since the Fed started tightening. And sagging building permits aren’t pointing to a snappy comeback. In fact, the NAHB housing market index is barely above breakeven levels in April.

Also dissuading buyers is a soft rental market. An earlier surge in apartment construction has lifted apartment vacancy rates to 6.7% in March from under 4% in 2021. Though not high historically, vacancy rates are now modestly above pre-pandemic levels. As a result, rent growth has moderated from earlier dizzying heights. After soaring almost 16% y/y in early 2022, Zillow’s Observed Rent Index cooled to a 3.6% pace in March. According to Apartment List, the median rent paid for new apartment leases has fallen modestly in the past year. Softer rents will help on the inflation front, while also weighing on sales. It's cheaper to rent than own a home. CBRE estimates that average new mortgage payments are 38% above average apartment rents as of late 2023. The wide affordability gap favouring renters didn’t exist before prices went berserk in the pandemic.

A struggling housing market suggests restrictive monetary policy is working to cool demand—at least for the 4% of GDP tied to residential construction. But unless the remaining 96% of the economy loses resiliency, as we suspect it will, policy rates could stay high for longer, hurting those trying to get a leg up on the housing ladder.