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Viewpoint: Interest rates and the supply of residential homes on the market

June 10, 2022 - By Merit McIntyre

The residential real estate market in desirable cities like Boston and its suburbs is as hot as ever. Double-digit asking prices, offers tens of thousands of dollars over asking, cash buyers, no contingencies — and all fed further by constrained supply.  One reason for the frenzy is the nearly free money that low inflation and Federal Reserve Bank policies have provided for most of the last 20 years. Well, that’s changing.

So: Crash, correct, or cool?

Despite the Fed’s relatively aggressive recent interest rate hikes resulting in growing mortgage loan interest rates, the real estate market in Greater Boston has cooled only slightly, from red hot to bright orange. And when markets rise, consumers tend to take their focus off price and move to cost. Cost is immediate; price is longer term.

A buyer may justify purchasing a home for $900,000 that sold two years ago for $700,000 because her focus is on cost, not price. That buyer, financing $720,000, would have a principal and interest cost of $3,874 at 3.75% interest. Rather than focusing on the somewhat scary price of $900,000, the buyer focuses on a cost of under $4,000 per month. With interest rates now rising and currently hovering around 5.25%, that cost just went to $4,515 — an increase of 13% — and the increase may alter the buyer’s cost calculation.

If history repeats itself, lenders will begin to push adjustable-rate mortgages so buyers can more often justify the cost, or what they will pay in the immediate future. 

While the real estate market may cool, history indicates it won’t go into a deep freeze and the effect won’t be long lasting. A continuing shortage of housing inventory will tend to keep the market active if not aflame.

The 50-something population is anchoring. They have no real reason to move. Most are at least a decade away from retirement, their children are staying longer in the “big house,” and many of their lives have actually become more manageable, with work-at-home or hybrid work schedules.  The baby boomers have equity, and many have the ability to assist their millennial children with a down payment.

With 50-somethings staying put, combined with a decline in new construction, it’s not unusual to see more than 100 prospective buyers trekking through an open house, checkbooks in hand and parents in tow. There’s just not enough on the market, even with dad and mom contributing to the down payment. 

In Massachusetts in 2021, the demand for new housing was 19,587 units, but only 15,600 were on the market.  We are a full three years into the current housing deficit, entering 2022 with a shortage of 12,000 homes. That’s not going to be made up soon.

There are only two scenarios in which the housing market would cool significantly. The first would be for buyers to check out and move to a market flush with inventory. The second would be for local and state governments to meaningfully reduce development restrictions and implement fast-track housing approvals. The Baker administration in Massachusetts is trying to do that, but it’s an uphill battle against the commonwealth’s enduring tradition of local control.

Places like Massachusetts will probably see a little of both reactions to the tight housing market and high prices. But even with abruptly rising interest rates, an inventory shortfall will sustain the housing market for years to come.

Merit McIntyre is president and chief executive officer of Advisors Living, the residential sales platform of Boston Realty Advisors in Massachusetts.

Read full article on Boston Business Journal.

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