The pandemic has been super weird. That's probably the biggest understatement of the last two years, but there's no adequate way to use words to describe how pretzel-shaped the economy has become since early 2020 lockdowns started. It's not the fault of any one thing, really -- it's a whole global mishmash of problems, touching absolutely everything that currently occupies space and time. And because of that, it takes a whole global mishmash of efforts to try to right the boat.
One of the many efforts currently implemented is a strategic monthly purchase of $120 billion in Treasury and mortgage-backed securities each month by the United States Federal Reserve. By doing this, the Fed can keep money flowing to lenders at cheap rates, giving the whole economy some hot air balloon-level uplift.
The problem, of course, comes when inflation and other economic indicators hit a level that hint that the economy has reached a lofty-enough point that it may be in danger of melting in the sun. That's the issue that we're approaching right now: Icarus is approaching critical mass, and by Icarus, I mean inflation...
Fed bond buybacks and interest rates
After the September meeting of the Fed, Chairman Jerome Powell told the press that change may be on the horizon in the form of tapering of bond purchases. This doesn't mean they're going to throw the brakes on buys; simply that the Federal Reserve means to start squeezing the brakes a bit. It will take some time to completely close the cash pipeline, but many expect that the bond purchasing programs will completely wind down by mid-to-late 2022.
At that point, there's also a very good chance that interest rates will be raised to balance the equation. For homebuyers and investors who weren't in the market in the early-to-mid-2000s, the thought of rates above the historic lows we've been seeing for over a decade now could be pretty terrifying. After all, what homebuyer is going to borrow at 4.25% for a home purchase?
Math time: What higher interest rates actually look like
According to the National Association of Realtors, the median existing home purchase in August 2021 was $363,800. As of Oct. 19, 2021, the average interest rate for a 30-year mortgage is 3.21%. The average down payment in 2020 was 6.6% of the purchase price. These are things we know and can use to kind of examine what rate changes mean to buyers.
Given this, the most up-to-date information we've got, that median home mortgage at 3.21% means a $1,471 monthly principal and interest payment. That's what the median American is willing to pay for their home in today's market.
Generally speaking, the Fed is reluctant to raise interest rates more than a quarter of a percent at a time, partially in an effort to prevent commercial borrowers from getting too spooked and thus passing that spookiness on to their customers. So, if we assume that a quarter of a percent hike is coming near the end of 2022 but all else remains more or less the same, that $363,800 principal and interest mortgage payment is increased to $1,525, a mere $54 per month change for any given new buyer, or about a 3.6% increase in monthly payments.
The Millionacres bottom line
Even if the Fed stops buying bonds and raises its interest rate by a quarter of a percent at the end of 2022, a lot of things would have to change to really extinguish American's gusto for real estate. Even though existing home sales decreased by 2% from July 2021 to August 2021, inventory continued to decrease as well. During the same period, unsold homes decreased by 1.5% to 1.29 million units, or just 2.6 months' worth of inventory.
New-construction properties are still plagued by frustrating delays and, in some cases, the inability to even start due to labor and materials shortages, so it's impossible for builders to help make up the difference in much-needed units. This extends well beyond the SFR market and into absolutely every real estate type.
Honestly, if things remain more or less as they are, and we already have been told repeatedly that we can expect supplies of absolutely everything to be short through at least mid-2022, I can't see the Fed throttling back bond buying and the potential of raising interest rates to be more than a tiny blip on the radar. Homebuyers ultimately buy a payment, and an extra 3.6% isn't going to make a lot of difference unless they're already stretched beyond capacity (which is a whole different issue).
Inventory shortages are likely to continue for some time as we struggle to catch up to the demand for for-purchase homes, rentals, and even many classes of commercial structures. Unless the Fed takes an unusual step and decides to hike rates dramatically, the real estate market should continue to be the drama llama we've come to expect over the last several years, Fed taper or no Fed taper.