How inflation is impacting the housing market

Published: Mar 29, 2022
The Fed has started its process of raising rates and mortgages are going up as well, as higher prices and a competitive home market add fuel to the inflationary fire. (Credit: Getty Images)

By Tom Brady

Federal Reserve chairman Jerome Powell recently hit stage 5 of the five stages of acceptance about inflation.

Powell officially signaled the reality of persistent inflation back in December, when the Fed made clear that it planned to pull back on bond purchases more quickly than planned, and target several rate hikes for 2022, perhaps more in 2023.

On March 16, the Fed raised the benchmark overnight interest rate by a quarter of a percentage point from near-zero, and some are talking about a bigger increase at the next policy meeting in May.

“I have everything on the table right now. If we need to do 50 (basis points), 50 is what we'll do,” San Francisco Fed President Mary Daly said on March 23 at an event organized by Bloomberg. “With the labor market so strong, inflation, inflation, inflation is top of everyone's mind.”

Powell said the central bank must move “expeditiously” to raise rates and possibly “more aggressively” to keep inflation from becoming entrenched.

“The labor market is very strong, and inflation is much too high,” Powell told a National Association for Business Economics conference on March 21. “There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability.”

Another factor that will make it difficult to tame higher inflation, which hit 7.9 percent in February, is the increase in energy costs caused by the war in Ukraine and a boycott of Russian oil exports. But with inflation rates over 7 percent in December and January, and 6.8 percent in November, many economists felt the Fed was too slow to tighten the money supply.

(Read more: What happens to real estate during inflation?)

How do mortgage rates correlate to inflation?

Short-term inflation generally has little impact on mortgage rates, which are more closely linked to the 10-year Treasury bill, where rates tend to rise slowly. The interest rate the Fed controls is what banks and credit unions use to lend to each other overnight. This is a very different lending market than the one for mortgages, where banks compete with one another for business.

The rate on the 10-year T-bill hit 2.46 percent on March 28. A week earlier, it was at 2.15 percent, and as recently as early December the yield was at 1.35 percent.

Mortgage rates have been following the Treasury bill, rising steadily since the end of last year, with the 30-year rate hitting 4.8 percent on March 28. For most of 2021, 30-year mortgages could be had for around 3 percent, and refinance activity was robust as many homeowners rushed to take advantage of the lower rates.

Many observers expect mortgage rates to settle around 5 percent, and many economists point out that number still qualifies as historically low.

As rates for primary residences rise, the impact on borrowing for investors in the single family residential (SFR) sector is softened by the fact that they’re already paying higher rates. And owning property brings with it numerous benefits.

“Even in this crazy environment, it’s still a relatively safe investment,” said Dennis Bron, vice president of growth for Mynd.

SFR investors earn cash from collecting rent, and owners who buy and hold are able to employ several strategies to reduce their tax burden, writing off many expenses associated with a rental property, and taking depreciation on a home.

Concerns about jobs drove Fed policy

For most of 2021, Powell and his colleagues at the Fed expressed their concerns about the job market, and were reluctant to make any moves that would prevent the economy from reaching full employment. (The unemployment rate was 3.8 percent in February; it peaked at 14.7 percent in April 2020, the height of the pandemic.)

Frederic Mishkin, a Columbia University professor and former Fed governor, said in December that the economy had already reached full employment and the Fed was “much too optimistic on the inflation front,” and distracted by its focus on the labor market.

Mishkin said then that he feared the Fed would have to raise rates higher than it would otherwise need to if it had acted earlier.

“The Fed is behind the curve,” Mishkin said in an interview with CNBC. “The reality is inflation is higher than they anticipated and it’s more permanent than they anticipated.”

It seems Professor Mishkin’s fears were not unfounded.

How is real estate a hedge against inflation?

Investing in real estate offers a couple of advantages during inflationary periods, and this recent runup is no exception. And there is scads of evidence that a diversified portfolio, one that has 20 percent or more invested in real estate, offers strong and stable returns.

Doug Brien, the CEO of Mynd, believes an inflationary environment creates more opportunities for investors in the SFR market.

“It’s an attractive option because rents are bound to rise along with inflation,” Brien said, which increases the cash flow for property owners.

As rates rise, demand for rental homes is likely to increase as well, he added.

“If it becomes more expensive for potential buyers to finance a purchase, fewer will be able to afford it,” Brien said. “This will increase demand for single family homes and create more upward pressure on rental prices.”

The old adage is that real estate acts as a hedge inflation, and there are a number of reasons for that, including:

  • Housing prices rise with inflation, so owners will see appreciation. With the country some 4 million units short of demand, upward pressure on prices means that longtime owners have already seen their assets increase more quickly than at any time in recent memory.
  • Mortgage payments do not change over time, but inflation means the money paid back in the future is worth less. As equity grows, fixed-rate payments stay the same.
  • Rents on single family homes have been on a steady upward swing over the last year,  and inflationary pressures will hit the rental market as well.

Housing market’s rise preceded inflation surge

The runup in prices in the housing market started before the inflationary pressures of the last year, as a shortage of homes, and the pandemic-fueled migration to the suburbs and smaller cities, spurred bidding wars and double-digit-percentage hikes in many cities.

These increases are hitting families looking to buy in the single family residential (SFR) space, as well as investors, a group that now includes some deep-pocketed institutions like JP Morgan, Blackstone and the Toronto-based investment firm Tricon Residential, which plans to invest $5 billion in single family rental homes in the U.S. in partnership with Teacher Retirement System of Texas and Pacific Life Insurance Company.

“A lack of inventory is really jacking up home prices,” said Don Ganguly, senior vice president of Mynd Investment Management. With investors forced to pay higher prices because of the increased demand and the looming increase in rates, they are “not getting as much juice month-to-month with cash flow.”

The cost to build homes has risen dramatically in the last two years, as lumber prices went through the roof (literally, they were four times their normal price in May and at one point were said to be adding $36,000 to the price of a house), even as a labor shortage and supply chain issues plagued many developers.

Many observers of the housing market are trying to calibrate the new normal in the housing market, as prices are still high and going higher in the hottest markets, like Atlanta, Phoenix, Raleigh, Charlotte, Tampa and Austin. It’s going to take several years for builders to overcome the housing shortage; with more millennials looking to buy their own homes, that 4-million-home shortage could prove to be stubborn.

For those already in the SFR market, these have been heady days. And many experts believe that there are still good opportunities, if investors do their homework and find properties that have potential.

“Rental housing demand is going to continue. Some percentage of people are going to work out of their houses for some period of time,” Ganguly said. “A lot of those people may not want to buy, so you are going to have a spillover from the apartment rental cohort who are looking for a home in the rental market.”

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