Economist: Fed Rate Hike Could Slow Home Sales In 2016

The market potential for existing-home sales decreased by 2.1% in November compared with October and decreased by 8.0% compared with November 2014, according to First American Financial Corp.’s proprietary Potential Home Sales model.

The model provides a gauge on whether existing-home sales are under or over their long-run potential level based on current market fundamentals.

However, according to the model, the seasonally adjusted, annualized rate of potential existing-home sales has increased 72.6% from the low point reached in February 2009.

The potential home sales rate in the model decreased by 118,500 units in November. That’s a decrease of about 810,000 units compared with the peak seen in February 2014.

The model’s current underperformance gap is an estimated 147,000, which is significantly less than the sales potential gap of 1.7 million existing-home sales in February 2014.

So how much of an impact will the Fed’s recent rate hike have on the model moving forward?

“The model indicates the housing market’s potential for existing-home sales continued to pre-adjust to the increase in the Federal Fund Rate announced [recently] by the Federal Reserve,” says Mark Fleming, chief economist for First American, in a statement. “While the increase in the short-term rate only indirectly influences long-term interest rates, the Fed signaled a continued modest path of rate increases.

“According to the model, a modest path of rate increases will moderately increase the cost of mortgage financing and reduce the pace of house price appreciation in 2016,” Fleming says. “The rise in interest rates combined with a continued, yet slower, pace of appreciation were the most important market fundamentals that reduced the potential home sales rate in the model this month.”

So, how much will the Fed’s rate hike impact affordability?

“Until [the Fed’s rate hike], rates had not increased since before the iPhone was invented,” Fleming says. “Yet, the impact of [the rate hike] on first-time home buyer affordability moving forward remains small. Our Real Estate Sentiment Index indicates that first-time home buyers are the most likely to be impacted by rising rates, but that their home-buying decisions will likely be unaffected until mortgage rates surpass five percent. Existing homeowners, mostly with fixed-rate loans, will be less impacted by any potential increase in long-term mortgage rates.

“With or without Federal Reserve intervention, the income a first-time home buyer will need to buy today’s starter home a year from now will increase,” Fleming adds. “Yet, I estimate the difference to be only $700 more in 2016 as the Fed starts to raise rates. The price of admission for homeownership will rise, in part, because of the leverage-assisted asset inflation caused by the low-rate environment. The time for rock-bottom mortgage rates needed to end and the end of this era will only have a very modest impact on affordability for the first-time homebuyer.”

First American is forecasting that annual existing-home sales will reach 5.5 million by the end of 2016.

“Housing demand will be dominated by emerging ethnically diverse first-time homebuyer households, as older existing homeowners will have a reduced incentive to sell their homes in a higher rate environment,” Fleming says.


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