What is happening in the real estate market?

Housing construction in the U.S. surged in May, and prices rose despite the highest interest rates in 15 years. This resilience surprised some economists.

Gianni Martinez31 years old, I thought it would be quite easy to buy an apartment. Mortgage rates are currently hovering around 7 percent - the highest since 2007 - due to the Federal Reserve's efforts to curb inflation. Central bankers have raised the official interest rate to about 5 percent over the past 15 months, leading to increased borrowing costs throughout the economy.

Mr. Martinez, a technology worker, expected that this would reduce the demand for real estate in Miami. But instead, he found himself in fierce competition for one- or two-bedroom apartments near the ocean. He made seven or eight offers and is ready to pay a 25 percent down payment, but he keeps losing, often to those who pay in cash rather than taking out an expensive mortgage.

“Due to interest rates at 7 percent, I didn’t think there would be such competition - but for cash buyers, it doesn’t matter,” said Mr. Martinez, noting that he is competing with foreign buyers and other young people who come to showings with their parents, implying that mom or dad might help cover the costs.

“When there is a properly valued asset, it’s madness,” he said.

The Federal Reserve's rate hikes are aimed at slowing down the American economy, including regulating the real estate market to curb inflation. Initially, these measures quickly worked to weaken the interest rate-sensitive sectors of the economy: real estate markets in the United States significantly declined last year. However, this cooling seems to be starting to slip away.

Housing prices decreased across the country at the end of 2022, but over the past few months, they have started to recover, coinciding with a strong market growth in southern cities, including Miami, Tampa, and Charlotte. Data to be released on Tuesday will show whether this trend continues. Data from last week indicated that national housing construction suddenly surged in May, reaching its highest level since 2016, and there was also an increase in building permit applications.

The real estate market is starting to gain a second wind. The rise in housing prices will not significantly affect official inflation figures - they are based on rental costs rather than the expenses of purchasing a home. However, this revival is a sign of how difficult it is for the Federal Reserve to curb momentum in the economy when the labor market remains strong and consumers' financial situation is generally healthier than before the pandemic.

“This is another factor: things are not cooling down as much as they expected,” said Kathy Bostjancic, chief economist at Nationwide Mutual.

This could be significant for policy: officials at the Federal Reserve believe that the economy needs some time to grow at a pace below its full potential in order for inflation to fully decrease. In a weak economy, consumers are less willing to buy, which makes it difficult for companies to set high prices.

The question is whether the economy can slow down enough when the real estate market stabilizes or even starts to pick up, which encourages developers to be more optimistic, construction companies to hire workers, and property owners to feel a psychological boost from the increase in the value of their homes.

For now, at least, the head of the Federal Reserve does not seem to be concerned.

"The national real estate market has stabilized and may have even increased slightly, but at a much lower level than before," said Federal Reserve Chairman Jerome H. Powell at a meeting with lawmakers last week, adding the next day that "you could even say it has bottomed out."

The increase in rates has significantly reduced the sales of existing homes, he said, although the demand for new homes is supported by two long-term trends.

Millennials, the largest generation in America, are currently aged between 20 and 30, which are the peak years for moving out on their own and buying a home.

The shift to remote work during the pandemic seems to have encouraged people who would otherwise have stayed with neighbors or parents to live independently, according to recent research involving Adam Ozimek, the chief economist at the Economic Innovation Group.

“Remote work means working from home for many people,” said Mr. Ozimek. “It really increases the value of space.”

At the same time, affordable housing is becoming increasingly scarce. This is also partly due to the actions of the Federal Reserve. Many people refinanced their mortgages when interest rates were at historic lows in 2020 and 2021, and now they are reluctant to sell and lose those cheap mortgages.

"The most surprising thing about this housing market is how the rise in interest rates has affected demand and supply almost equally," said Daryl Fairweather, chief economist at Redfin. She noted that demand may have decreased slightly, but builders are gaining an advantage due to the "extreme shortage of supply."

As long as young people continue to place bets on homes and the supply remains insufficient, prices and construction will continue to rise unexpectedly.

“Demand turned out to be better than we expected from first-time homebuyers,” said Michael Fratantoni, chief economist of the Mortgage Bankers Association. Ms. Bostjancic stated that the latest housing market data is likely to sway the Federal Reserve towards raising interest rates. Officials paused rate hikes in June after 10 consecutive increases but suggested that they might raise them two more times in 2023, including at the next meeting next month.

If there is a positive aspect to the Federal Reserve System, it is that rising housing prices do not directly reflect inflation. American price indicators use rent to calculate housing costs as they attempt to account for the cost of consumption. Buying a home is, in particular, a financial investment.

The growth of rental prices has been slowing down for several months, which is gradually reflected in the official inflation data when leases are renewed.

“The growth of rental prices is slowing down,” said Igor Popov, chief economist at Apartment List. “There aren’t many new trends being felt right now.”

Nevertheless, at least one official from the Federal Reserve is concerned that the revival of the real estate market could limit the opportunities to slow down the growth of rental prices. As housing prices rise, some investors and landlords may decide either to raise prices or to shift from renting homes to buying and selling them, which would reduce the supply of rental housing.

“The revival of the real estate market raises questions about how sustainably rental rates will decline,” said Federal Reserve Board member Christopher Waller in his speech last month.

He said that the increase "even with significantly higher mortgage rates" raises questions "about how long the advantage of slowing rent growth will last."