Housing affordability is locking in 'homeowners into current interest rates,' economist says

Zillow Economist Nicole Bachaud sits down with Yahoo Finance Live to examine the decline in exisitng home sales, rising mortgage rates, and the state of U.S. homebuying as rent prices also increase.

Video Transcript

DAVE BRIGGS: Sky high mortgage rates cooling demand for houses in the US as the Fed tries to tackle inflation. We're awaiting some key data this week, starting with the Case-Shiller Home Price Index out tomorrow. Zillow senior economist Nicole Bachaud joins us now. Nicole, nice to see you. A lot of this data so lagging, it's hard to know what to do with it. What's your anticipation of what we'll hear tomorrow and throughout the week?

NICOLE BACHAUD: So we're going to hear tomorrow that home prices and home values have still been declining on a monthly level nationally and in most large markets. That's going to continue likely for the rest of this year, as affordability challenges really reign on buyers' budgets and sellers' decisions on whether or not to list their homes. We're going to continue to see affordability constraints and constrained inventory throughout the next year in this housing market.

SEANA SMITH: Nicole, you just mentioned constrained inventory. I guess you don't expect that to improve any time soon. Taking a longer term outlook maybe a year, two years, three years down the line, when do you expect to see that balance return when it comes to supply versus demand?

NICOLE BACHAUD: Well, when we look at where inventory is at right now, we're not anywhere near where we were before the pandemic. And I don't think we're going to get back to that point anytime soon. We're still seeing new construction at a higher level than it was pre-pandemic, but it's pulled back quite a bit from the 2021 highs when the construction market was really booming.

Now that affordability has started to hit both buyers and sellers, we're seeing a lot of existing homeowners locked into their current interest rates. That's going to lead to lower-- new homes coming onto the market from those existing inventory stock. So that's going to lead to more inventory constraints. And with the large number of demand, the people who want to be buying homes, if those homes are affordable, that's not going anywhere. And so this constraint inventory is really what's going to be keeping affordability pressures on the market and keeping prices from dipping down too low.

DAVE BRIGGS: Some pretty dire predictions, though, about the expected fall of home prices. One from the National Association of Realtors said 20% drop in home values next year. Are you buying that?

NICOLE BACHAUD: I don't think we're going to see anything near those extreme levels of price drops, right? We're going to continue to see these small declines throughout the rest of this year as the rebalancing takes place. But again, because we're going to see such low levels of inventory, that will likely keep us from seeing too low of drops of those home prices.

So especially when we look at the fact that home values are still up over 40% from where they were in 2019 at this time in that year, and so existing homeowners still have a huge swath of equity that they've gained over the last couple of years. And the majority of that is likely not going to go anywhere.

DAVE BRIGGS: So to be clear, when you say rebalancing, no one's going to lose value in their home compared to 2019 levels. Just coming down a bit from record highs?

NICOLE BACHAUD: Yeah, for the majority of markets, we're just going to see this kind of smoothing out from where we're at right now. And especially in terms of affordability, markets that have seen the biggest worsening of affordability, right, when you look at local incomes versus where mortgage rates are taking current mortgage payments, the markets where we've seen the biggest increase in that affordability burden, that's where we're going to see prices coming down the most. But it's not likely going to be anywhere near the amount of appreciation we've seen in the past 2 and 1/2 years.

DAVE BRIGGS: Mortgage rates, of course, are the story. The 30-year fixed right now averaging 694, up slightly from the week prior, but more than double from a year prior. How high do you think they'll get? The Fed still has what appears to be a 75 point hike, if not a 50 after that in December. And some feel mortgage rates could eclipse 8%.

NICOLE BACHAUD: Yeah, absolutely. It's very challenging to estimate where exactly we're going to see mortgage rates going. There are a lot of factors that influence mortgage rate changes. We know that rates are likely going to stay much higher than those pandemic era lows. And so we're not going to be expecting a return anywhere near 3% anytime soon. So when looking at the next couple of months to the next couple of years, we're likely looking at higher rates than we had when there was this big frenzied housing market.

And we're likely not going to return to that because this affordability challenge is going to be existing. Even if rates went down to 5%, we're still going to see affordability challenges with the current home prices. And if rates get any higher, affordability is going to be a major challenge for most households. So that's likely not going to change much as rates are kind of fluctuating throughout the year.

DAVE BRIGGS: Do we see 8% or 5% first?

NICOLE BACHAUD: Yeah, that's really hard to tell. You know, I think rates are likely going to stick around kind of the level that they're at now with minor fluctuations. But it's really difficult to pin that down.

DAVE BRIGGS: They're more reliant on the 10-year than they are the exact correlation to Fed hikes. Rent has been a different story. It appears we're seeing a little leveling out. What are you seeing in the data?

NICOLE BACHAUD: Yes, so rents are definitely strong compared to where they were pre-pandemic. Even as the for sale side of the market is softening, we're still seeing rents being pretty strong in terms of rent growth and rent price levels. It's actually cheaper in most markets to rent than it is to pay for a monthly mortgage payment. And that's definitely weighing on people's decision making of, should I rent or should I buy?

We're seeing a lot of people who are being priced out of the for sale market going back to rentals. And that's going to boost demand for that market. We're seeing really low vacancy rates. We're seeing new construction builders switching over to multifamily properties, which will help reduce some of that burden. But it's likely that rent growth is going to stay high, especially compared to the appreciation levels that we saw pre-pandemic.

DAVE BRIGGS: Yeah, we've got the biggest level of multifamily construction going on since the mid 1970s. So that is certainly a good rental news story. Are there sectors, regions of the country, or even cities, Nicole, that you think might not apply to that balancing out rule, that might be actually in jeopardy of losing a lot of home value in the year ahead?

NICOLE BACHAUD: What we're seeing is markets that have seen the biggest change in affordability are where home prices are slowing down and dropping the most. That's mostly in the Western half of the United States. Everything from Austin, which experienced near 50% annual appreciation during the pandemic, over to Phoenix and San Francisco, all of those markets are seeing pretty significant declines in prices over the past couple of months, but again, nowhere near the level of appreciation that we saw since 2019.

So even though we're seeing maybe 2% drops in Phoenix the last couple of months in a row, that's not eating into that 60% growth we've seen since 2019.

DAVE BRIGGS: Yeah, you just worry about those people that bought at the pandemic peaks and may, at some point, realize they could be underwater. But hopefully, we do not see that level. Nicole Bachoud, we really appreciate you being with us.