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Can Rising Mortgage Interest Rates Cause a Housing Market Crash?

Looking at the real estate market, many people are wondering — can rising mortgage interest rates cause a housing market crash? According to the National…

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Looking at the real estate market, many people are wondering — can rising mortgage interest rates cause a housing market crash? According to the National Association of Realtors: “The latest contract signings mark six consecutive months of declines and are at the slowest pace in nearly a decade. Month-over-month, only the Midwest saw an increase in pending sales in April, and all regions experienced declines year-over-year.”

Many analysts and everyday consumers are wondering whether they should brace for another 2007/08-type financial crisis. With the recent reduction in real economic activity and rise in mortgage rates, it’s easy to see why there’s fear in the air. However, I’d argue that a housing market crash is an exaggeration, and we’re more likely to experience a minor rough patch rather than an economic atrocity.

Fundamental Analysis

I’d like to start off by discussing the economic climate to contextualize the consumer environment we’re in.

First of all, it’s necessary to understand that the current inflation has been caused by push and synthetic pull factors. The latter pertains to a synthetic expansion of the economy and the former relates to pandemic lockdowns that have reduced the efficiency of industrial production. As a result, we’ve experienced a skyrocketing real estate market as many buyers have taken advantage of lower mortgage rates.

In addition, the excess dry-powder from stimulus checks and wage increases provided home buyers with additional confidence.

The backdrop of it all is a stagnating economy. Although it’s cooled down a tad, the inflation rate has been holding at over 8%. Thus, policymakers are forced to send the U.S. economy into a sporadic contraction to stabilize price levels. In fact, the treasury yield curve spread between long-duration and short-dated bonds implies that interest rates will need to soften in the medium term to re-ignite economic activity.

Source: Gurufocus
Source: Gurufocus

Real Estate Specific Factors

It’s forecasted that 30-year mortgage rates could hit 6.2% by the first quarter of next year, which could soften purchases significantly considering price elasticity. Moreover, the U.S. household financial obligations rate has reached 14%, providing less scope for consumers to take on debt financing for home purchases.

Furthermore, there are a few key indicators that provide cause for concern. For example, the National Association of Realtors claim that pending home sales prices decreased by 3.9% in April to the lowest level in two years. This is interesting, as pending sales provide a leading indicator of the housing market’s health. Additionally, other leading indicators such as building permits (down by 3% in April) and new home sales (down by 20%) are also in poor shape.

Lastly, a worthwhile observation lies in publicly traded real estate assets. The Dow Jones Equity REIT Total Return Index (REIT.IND) has drawn down by more than 14% in the past six months, indicating that investors expect a decline in mixed purpose real estate valuations. Marked asset prices provide a solid indication of future asset valuations in the private markets. Thus, the downward trajectory of the index should be of concern. But will it mean a housing market crash?

My Final Verdict on a Housing Market Crash

So can rising mortgage interest rates cause a housing market crash? There’s no doubt that the housing market will soften. In fact, it could experience a severe drawdown in the coming years. Nevertheless, I believe that we’ll see a cyclical decline rather than a life-changing housing market crash. The earlier 2000s’ housing crisis occurred because of an asset bubble within the debt market instead of a cyclical headwind. Thus, I see no similarities here.

On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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