Where Do We Go From Here?
The federal reserve is set to increase interest rates again in the first week of May 2022. Many experts expect the increase will be another 50 basis points. The 30-year fixed rate is currently hovering around the 5.25% mark. Many experts are predicting anywhere from another 3-5 rate hikes for the rest of 2022. Let’s quickly highlight what’s going on in the Minneapolis Saint Paul twin cities housing market and how rising interest rates have affected the local market thus far and where home values will be going in the near future.
- New listings are down 7.2% over the past year.
- Pending sales are down 9% over the past year.
- Inventory levels are down just over 13% over the past year.
- Average number of days on market is down a whopping 32% over the past year.
- Median Home Sales Price has increased 10.9% over the past year and just eclipses the August 2021 all time high here in March 2022.
- Housing affordability index is down just over 12% in the past year.
(source: Minneapolis Area Association of Realtors)
- Just over 50% of renters have now been priced out of the housing market. The number has likely grown as this chart is now a couple of months old.
- Fannie Mae predicts home price growth to have peaked here in Q1 2022
(Source: Fannie Mae)
So, what is the key takeaway here for the Minneapolis & Saint Paul Twin Cities housing market? Supply continues to shrink as sellers realize that should they decide to sell their home, their options for purchasing a new home are very low in the twin cities. Not only is there less to pick from now even compared to when we were in the peak of Covid season, but now interest rates continue to rise. This means if they sell their home where they had locked in a lower interest rate in the 3% to 4% range, they will now be subject to the higher interest rates on their new purchase.
The higher interest rates complicate things not only for the first-time home buyers but also for those looking to trade up to a larger home, or even those looking to pocket equity from their home sale and find a similar size home within a 15–20-minute drive of their current home.
Some people believe the sudden interest rate increases may lead to a housing crash or correction like we saw in 2007-2008 and that inevitably there will be a large decrease in purchases. That in turn will flood the market with a much larger housing supply. Unfortunately, this theory tends to neglect the high levels of inflation of CPI we are currently facing, which we did not experience in the last housing crash.
We continue to see print after print of inflation over 8% yet the American public was assured inflation would be “transitory” by political leaders and the federal reserve. The fed has since lost some credibility and is now backed against a wall where they will not want to lose credibility on defeating inflation.
Clearly the inflation problem is not going away as soon as we were told and is likely here to stay, the question is at what level? As long as the rate of inflation is greater than interest rates (specifically the 30-year fixed rate), home prices won’t be going down much. Couple that with the fact the Russia-Ukraine war has caused the United States to continue to borrow and spend even more money.
We have went from spending trillions on stimulus to now spending hundreds of billions helping Ukraine, NATO and surrounding NATO countries. Spending money is spending money no matter how you slice it and this continued spending will ensure that Americas inflation problem is certainly here to stay for now.
There are some silver linings in the current housing market though. As predicted by Fannie Mae and other experts, it is unlikely that Minneapolis home prices will continue to increase at the rates they did the past two years. This is simply because they no longer can. Despite demand levels still outweighing the housing supply numbers, Americans are having to spend more on everyday necessities such as food and fuel. Experts suggested the average American family is spending $5,000.00 more for the same basket of goods in 2022 as they did in 2021.
American workers are also not getting raises high enough to offset the higher levels of inflation. With less disposable income and a higher WACC, (weighted average cost of capital) consumers are facing a double-edged sword and simply cannot afford to pay the continued elevated price increases the Minneapolis Saint Paul housing market saw the last two years.
Minneapolis just reached a new all-time high for median home prices in March of 2022 and this would likely be what charting analysts see as a “double top”. Meaning prices may go slightly higher here in the very short term but later this summer, fall and winter, prices will drop back down again from the all-time highs as purchasing power of the Minneapolis and Saint Paul buyers’ market diminishes. The question is how great will this drop be?
This drop is unlikely to be a large one or any sort of housing crash like in 2007-2008. Lending practices are now far more conservative than before. Most buyers simply will not be approved on lending terms that were present prior to the last housing collapse. Inflation keeps buyers from being able to pay much more for anything, but it also prevents asset prices from cratering. So, it would appear the Minneapolis Saint Paul housing market is now in a state of perpetual limbo where prices will be relatively stuck the rest of 2022 if not trend down after Q2.
So, what should you keep an eye on? The main KPIs to watch now will be the overall stock market performance and the unemployment figures. As American consumers have less disposable income due to higher prices for necessities, they will be less likely to spend money on products or services they do not need. These spending cutbacks could have negative consequences for the hospitality, retail and travel industries especially. If the spending cutbacks from consumers are bad enough, business revenues could be affected to the point where they are faced with laying off workers like they did during the covid pandemic, and the unemployment rate could rise again.
The secret about the unemployment rate is that they do not count the people who have given up looking for work. The labor force participation rate is a better indicator of overall health of the labor market. According to the chart below, only about 6 in 10 Americans are actually working or actively looking for work. If demand for goods and services drops due to persistently high inflation, this could cause waves through the financial system, stock market and debt bond market. This in turn could cause a significant decrease in real estate values, though unlikely the type of decrease that was seen in the last housing crash.
However, the federal reserve could backtrack and decrease interest rates if the stock market sells off enough from the current tightening cycle, if spending decreases to the point unemployment begins rising again or if short-term interest rates begin to spike. If they do backtrack, they pretty much insure inflated real estate values in the Minneapolis and Saint Paul housing market will continue to remain elevated for the foreseeable future.