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Real estate: Midwest is ‘last regional bastion of affordability’ for homebuying, economist says

Zillow Senior Economist Jeff Tucker breaks down the outlook of the housing market and mortgage rates following the Fed's latest rate hike, including regional home pricing trends ahead of 2023.

Video Transcript


DAVID BRIGGS: Fed Chair Jerome Powell saying inflation in the housing market could start to cool by the middle of 2023. But will another 50 point hike further punish the housing sector? Joining us now is Zillow Senior Economist Jeff Tucker. Jeff, good to see you. How will today's decision by the Fed impact the housing sector that the Fed chair said, quote, "had weakened significantly?"

JEFF TUCKER: Yeah, you know, today's announcement was not a surprise in terms of the actual 50 basis point hike. So I think that news of slightly taking his foot off the brakes had been priced in for mortgages and 10-year treasuries already. So it still seems like a small step in the right direction. We've seen that 10-year Treasury working its way down from over 4% to 3 and 1/2%.

And critically for housing, that has brought the mortgage rate down on a 30-year mortgage from over 7% back down to about 6 and 1/3%. That's really major progress in terms of improving affordability for homebuyers. And this-- it's a long road for us to get back from this high-inflation, high-rate environment to a more slow and steady low-inflation, less-costly environment. And we are making progress in that direction at this moment.

SEANA SMITH: Jeff, you mentioned the progress that we're making, the drop in mortgage rates. Do you expect that decline to continue? And where do you think rates are headed then if, in fact, we do see that decline continue?

JEFF TUCKER: I think that is the base case scenario right now. We're seeing a lot of goods inflation kind of turning the corner. And we have a lot of reason to expect shelter inflation also to turn the corner in the new year. The Zillow rent index year-over-year growth peaked back in February. That takes time to flow through to the CPI rent index.

So we expect sometime in the first or second quarter to actually see that begin to decelerate on a year-over-year basis. That's the single biggest component in services in the CPI. So putting that all together, I think the base case has to be that inflation kind of continues on this trajectory downward.

So what does that do to mortgages? I think that does bring us back into the 5% to 6% range over the course of 2023. The more optimistic scenario is that we make a lot of progress toward the lower end of that range. The less optimistic scenario is that we end up stalling in the upper 5%-- upper five-point something percent range for mortgages.

DAVID BRIGGS: Yeah, it really is hard to imagine rates getting much below 5%. In terms of housing prices, what's your prediction for '23?

JEFF TUCKER: Yeah, our forecast right now looking a year ahead is for prices to fall by maybe half to one percentage point from now, 12 months ahead. Either way, it's approximately flat. I know there are more bearish forecasts out there of more significant price declines.

I think the number one factor in our model stopping us from that prediction is the low inventory. Inventory has not built up in a big way. A lot of sellers are just staying put in their homes. So it actually means out there in the market, you don't see a glut of homes for sale. That has kind of helped keep a lid on some of those processes where prices actually begin to fall rapidly.

There's definitely local color to this, of course, where West Coast markets and some of the Inland West, like Phoenix and Las Vegas, they've already fallen maybe close to 10% from a peak back in about May or June. And I think they still have a little bit of room to come down. But at a national level, we just don't see this kind of inventory pressure of forced sellers or really motivated sellers. If anything, sellers are motivated, kind of stay put, hunker down, and stay warm by their 3% mortgage that they locked in back in 2021.

SEANA SMITH: Jeff, what does all this mean then for the rental market because price is still substantially higher year-over-year? I guess, on a month-over-month basis, you're starting-- the data that Zillow put together starting to see some improvement. So what does that mean in terms of rental prices? And how long until we see that reflected in the CPI data?

JEFF TUCKER: Yeah, we have seen rents-- asking rents actually begin to decline month-over-month in the last-- basically this winter, even beyond the normal seasonal trend. So it looks like there's a bit of mean reversion where that rent growth is cooling down really sharply. That is great news for renters. It's great news for the inflation measures.

But it's really at least a 12-month lag from that slowdown in our asking rent index filtering through to CPI for rent and owners' equivalent rent. It's hard to say, but I think maybe the best-case scenario is that February could turn out to be the peak for year-over-year CPI rent growth. That would just be 12 months after our rent index peaked. There could be a bit of a lag, maybe it's sometime in the spring. But we do know this is already bringing relief to renters either getting renewal-- renewal letters or going out there considering a new apartment to move into this winter.

DAVID BRIGGS: Yeah, interesting, really, to see where they're falling the fastest. New York and Seattle among the top five, not where you typically expect it. Speaking of regions, the Midwest appears to be the best place for first-time homebuyers, according to Zillow data. Why so?

JEFF TUCKER: It's all about affordability. Affordability has been holding back the housing market, especially holding back home sales volume all around the country. That one-two punch of price appreciation and higher mortgage rates means that places like Seattle, New York, Miami, that mortgage is just out of reach for a large swath of homebuyers at the moment.

So we looked around the country and where is the last kind of regional bastion of affordability? It's the Midwest. These are places where middle-class families' income is still enough to qualify to buy a nice family-sized home. Nobody likes paying higher interest, even in the Midwest, but there's a lot more folks who can qualify to buy a home there and where it's still looking like they're just in a good position to buy in those markets.

I thought it was striking, too, that those were some of the same markets you just highlighted where rent is now growing the fastest. These are the markets where young folks setting out looking for a place of their own, whether renting or buying, they're finding more opportunity kind of in the heartland, in the Midwest, and the Great Lakes regions. So in terms of housing market activity, that's where we expect it to be the busiest in the year ahead.

SEANA SMITH: Jeff, what about the trends of buying with family and friends? That's something that stuck out to me. A lot of us questioned it, whether or not that's a smart financial idea. I don't want you to weigh in on that. But that momentum really, I think, just signals exactly what's going on in the housing market right now and the fact that so many first-time homebuyers simply cannot afford it no matter where they are in the country.

JEFF TUCKER: That's absolutely right. It comes back to affordability. And this is a generation of Americans entering their mid-30s now. The core of the millennial generation is very numerous. There are several million extra people in their early 30s and late 20s right now, and they're just as determined as previous generations to get into homeownership, but they're running into the biggest affordability challenge in a generation, maybe that we've ever seen, thanks to that one-two punch of prices and mortgage rates.

So people are getting creative. They're thinking of other ways to get into homeownership. We have seen some other kind of life milestones are delayed for the millennial generation, things like marriage and having kids. So that kind of creates this situation where there are folks in their early 30s or late 20s who might think, OK, how about if my parents go in on a house with me?

How about if my friends and I go in on a house together? We've got a place to live. We know that the price-- you know, that our monthly rent isn't going to keep going up like if we stay in the rental market. So it's kind of folks looking for ways to get into homeownership.

And I'm definitely reassured that the way that they're doing it is not what we did in 2005 and 2006 with ninja loans and no underwriting and balloon payments. Mortgage underwriting is still rock solid and very strict, frankly, for homebuyers. That's why people are looking at these methods of just thinking, OK, who can I buy a house with if I can't just do it alone right now?

SEANA SMITH: I don't know. It still sounds a bit risky to me just in terms of owning a home with friends or other family members. I don't know. Maybe I'm an outlier there. Jeff Tucker, great to have you. Thanks so much for joining us this afternoon.