When attempting to make predictions about the state of residential real estate in 2024, one must bear in mind that two major factors impact the condition of any real estate market both at the macro and at the micro level i.e. the mortgage rate fluctuations and the supply and demand dynamics. You will find below, for your convenience, a synopsis of how these two variables influence the residential real estate market.
1). The Federal Reserve's battle against inflation and mortgage rate fluctuations
1-1). Understanding the connection between mortgage rates and inflation at the macro level
As a reminder, the Federal Reserve (the Fed) uses monetary policy tools to manage inflation and support economic stability. One key tool is the control of the federal funds rate, which indirectly influences mortgage rates.
a). Below is a simplified explanation of how the Fed's policy against inflation leads to mortgage rate fluctuations:
The Fed aims to keep inflation in check by setting a target inflation rate. To do this, the Fed adjusts the federal funds rate, which is the interest rate at which banks lend money to each other overnight. When the Fed raises the federal funds rate, it becomes more expensive for banks to borrow money. In response, banks increase the interest rates they charge consumers for various loans, including mortgages. Therefore, when the Fed raises or lowers interest rates to control inflation, it indirectly affects the cost of borrowing for home buyers.
b). Will the Fed lower or raise the interest rates next year?
Some specialists suggest that the Federal Reserve will gradually reduce interest rates in 2024, adopting a measured approach, with a focus on implementing changes predominantly in the second part of the year.
On December 13, 2023, the Fed decided to maintain the current interest rates, keeping the federal funds rate within the range of 5.25 to 5.5 %. The Fed's choice coincides with a decrease in inflation to 3.1% year-over-year in November. This marks the fourth instance in the last five meetings where the Fed has opted not to change rates after raising rates a total of 11 times in an attempt to curb high inflation. For the record, the previous rate hike by the Fed occurred in July 2023.
With only one rate increase in the past five meetings and a decline in the inflation rate, many observers of the Federal Reserve speculate that the institution might have concluded its series of rate hikes. However, let's refrain from hastily jumping to conclusions. In a recent interview, Federal Reserve Chairman Jerome Powell indicated that the Fed envisions implementing three rate cuts of 25 basis points each in 2024. Should there be only three interest rate hikes in 2024, it would undoubtedly be a positive signal for investors, sellers, and buyers that a new phase in monetary policy is looming.
1- 2). Understanding the impact of mortgage rates at the micro-level
At a micro level, it's crucial to understand that an increase in mortgage rates affects local real estate markets across neighborhoods in distinct ways, primarily influenced by differences in demographics, commuting convenience, and the quality of public schools. Below is a synopsis of how these factors contribute to these diverse effects.
a). Demographics
Income levels: Neighborhoods with higher average income levels may be less sensitive to mortgage rate increases, as residents in these areas may have more financial flexibility. Conversely, in lower-income neighborhoods, even a slight increase in mortgage rates can significantly impact affordability, potentially lessening demand.
Age and life stage: Different neighborhoods attract residents at various life stages. For example, an area with a higher concentration of first-time homebuyers may experience a more pronounced impact from rate hikes, as these buyers are typically more sensitive to changes in affordability.
b). Ease of commute:
Proximity to Employment Centers: Neighborhoods with convenient access to major employment hubs may be more resilient to mortgage rate increases. The importance of a short commute can outweigh the impact of higher mortgage rates for homebuyers who prioritize proximity to work.
Transportation infrastructure: Proximity to well-developed transportation infrastructure, such as the VTA or the Caltrain, or proximity to highways, can mitigate the negative effects of rate hikes. Homebuyers may be willing to absorb higher mortgage costs if the neighborhood offers easy commuting options.
c). Public schools and family-friendly amenities:
Schools: The quality of public schools is a significant factor influencing housing demand. In neighborhoods with top-rated schools, the impact of a mortgage rate hike may be less severe, as families are often willing to pay a premium for access to excellent education. Conversely, in areas with lower-rated schools, even a small increase in mortgage rates could deter potential buyers.
Family-friendly amenities: Neighborhoods with family-friendly amenities, such as parks and community centers, may continue to attract homebuyers despite higher mortgage rates. These amenities can contribute to the overall desirability of the neighborhood, offsetting some of the negative effects of increased borrowing costs.
2). Supply and demand dynamics
The balance between housing supply and demand is influenced by various factors, including construction rates, zoning policies, and population growth. Shifts in these dynamics can lead to changes in property values and market conditions.
Neighborhoods with low housing inventory and high demand may be less affected by mortgage rate hikes, as competition among buyers remains strong. Conversely, in areas with an oversupply of homes, an increase in mortgage rates could lead to more pronounced declines in property values.
Investor Activity: Areas with a higher proportion of investor-owned properties may experience different market dynamics. Investors, driven by different considerations than owner-occupiers, may respond to rate changes in unique ways, impacting local housing markets.
In conclusion, forecasting the
status of the residential real estate market in 2024 demands a nuanced
comprehension of the interaction among the two above-mentioned key factors,
coupled with the capacity to scrutinize the intricacies of the available data both
at a macro and micro level. As of now, the available data indicates that 2024
is set to be a more favorable year for the residential real estate market in
comparison to 2023.