Real Estate ETFs Respond to Rising Mortgage Rates – Part II

The recent hike in mortgage rates will likely continue to weaken sales trends and push home prices a bit lower over the next several months. The real estate ETF, IYR, already reflects a decline of around 10% in its valuation since early September 2021.

In the first part of this research article, I shared a historical chart of the average mortgage rate in the United States and some data suggesting that the average American consumer is somewhat tied to certain house price constraints based on average income. . As a general rule, mortgage payments should be kept below 50% of the borrower’s total net income. Depending on the borrower and the price of the house, many American borrowers may already be excluded from the market, even with interest rates of 3.25%.

Maximum home price affordability reached in early 2021

Maximum accessibility appears to have peaked in December 2020 and January 2021 – right after the COVID-19 crisis. This is likely correlated with lower interest rates, at a point below 2% in most of the United States, for homebuyers, while home prices were 20-40% below what. they are currently in most regions.

(Source: https://fred.stlouisfed.org)

The National Case / Shiller Home Price Index has soared 30% since May 2020

The Case / Shiller US National Home Price Average is a good measure of the national average home price. From the graph below, you can see the almost parabolic rise in house prices after the COVID-19 event of March 2020. This incredible rally represents an increase of over 30% in average house prices in the United States. in just over 13 months.

There is nothing similar on this graph, going back to 1988. This likely means that the process of the COVID-19 virus event created a perfect transition storm for the housing market – where the big earners may have moved to more rural areas or taken up a second or third residence when interest rates were favorable. But for average home buyers (first-time buyers or young adults), this may have pushed the affordability of home prices far beyond reasonable levels.

It will be interesting to see how the real estate market handles the new spending and tax policies that are currently being put in place by Congress – as well as whether this trend can continue for much longer with the threat of an interest rate hike. from the US Fed.

(Source: https://fred.stlouisfed.org)

Real estate ETFs are already showing signs of a changing market

This Daily IYR, IShares Real Estate ETF, shows how traders reacted to the spike in house prices and sales recently. I think the US real estate market is entering a transition that could take another 20 to 35 months to finally take hold. The issue of home affordability is one thing, but the economy must continue to grow at a reasonable rate for current price levels and affordability levels to be maintained.

In addition, uncertainty related to new policies, taxes, spending and the US debt ceiling is currently putting additional pressure on the real estate market. The two most important tax changes are limits on inheritance tax minimums (proposed at $ 1 million) and death tax minimums (which are reduced by almost 75%). These two major changes in tax laws will greatly affect the generational wealth transition, as the prices of homes and other assets could be taxed at much higher rates than in the past.

By putting these two fairly large unknowns ahead of the already overheated housing market, we could see the IYR drop to levels below $ 101 if the downward pressure on prices continues. A breakdown below $ 101 would indicate that a recent strong support level has been broken. Suggesting a break in the price trend and the potential for a new downward price trend to develop.

This IYR weekly chart shows that the $ 101 support level comes from the high price level just before the COVID-19 virus event (in February 2020). If IYR falls below that level after the incredible rally phase over the last 14 months, I think the downside potential of a move like this could push prices down an additional 15-25%, in maybe targeting $ 80 to $ 85.

It all depends on how consumers and the US Federal Reserve act over the next 6-12 months and how the US Congress acts to determine how and why these new spending bills are resolved. At the end of the day, the american economy has rebounded strongly over the past 13+ months and we are now entering a transitional phase in the US stock markets. This will likely make a transition to the US real estate market as well.

Over the next 24 months, I expect very large price fluctuations in the American Stock Exchange and other asset classes around the world. I think markets are starting to move away from the phase of continued recovery in central bank support and may enter a phase of reassessment as global traders try to identify the next big trends.

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For an overview of all of today’s economic events, check out our economic calendar.

Have a nice day!

Chris Vermeulen
Chief Market Strategist

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About Robert Valdivia

Robert Valdivia

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