Last week the national average rate on the 30-year fixed mortgage rose to 7.48%, the highest level in the U.S. since November 2000. A rise in bond yields on Monday triggered an increase in the 30-year mortgage rate, the most popular form of loan term.
The increase makes housing even more unaffordable than it already was, especially for starter homes. It also increases the likelihood that homeowners with far lower mortgage rates will stay in their homes rather than move to another location or type of home. Who wants to trade a 3% loan out for one that is 7.5%? In an endless feedback loop where nobody moves, housing supply levels remain tight, which further elevates prices, keeps inflation up and pushes the mortgage rates higher.
Many borrowers are now gambling on adjustable-rate mortgages (ARMs) that begin with lower interest rates for a few years before changing to fixed-rate terms. But even the five-year ARM was quoted at 6.2% last week. Similar to 2008, should rates continue moving higher, ARM borrowers could be in financial trouble when their loan converts into fixed rates.
But because real estate sales provide so many jobs, a prolonged slowdown in real estate sales could trigger a recession, as it did between 2008 and 2010. Each real estate transaction involves Realtors, closing agents, inspectors, appraisers, surveyors, handymen or licensed contractors and — except for cash deals — mortgage companies. If the Federal Reserve is really looking for a slowdown in the employment numbers, curbing real estate sales is one strategy to get there.
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High mortgage rates help real estate investment trust (REIT) subsectors — REITs such as Mid-America Apartment Communities Inc. MAA and AvalonBay Communities Inc. AVB, which rent apartments, and REITs that rent single-family homes such as Invitation Homes Inc. INVH and American Homes 4 Rent AMH.
Raymond James analyst Buck Horne recently maintained Outperform ratings on both Invitation Homes and American Homes 4 Rent. Horne raised the price target on Invitation Homes from $35 to $38 and raised the price target on American Homes 4 Rent from $36 to $40.
As long as buying a home remains difficult, demand for rentals will continue to be stable or rise. Homebuilders such as Lennar Corp. LEN and KB Home KBH are now building apartment and rental townhome complexes, and while eventually any significant increase in available rental units could negatively impact residential REITs, that day is still well off in the distance.
Another subsector that should benefit from the higher mortgage rates is self-storage REITs, such as Extra Space Storage Inc. EXR, CubeSmart CUBE and Public Storage Operating Co. PSA.
Apartments, condos and small townhomes don't typically provide a great deal of storage room, which should keep demand and prices up for self-storage units. But as with rental homes, the supply-demand ratio could also change if too many new self-storage buildings are constructed.
For now, the prospect of further Federal Reserve rate hikes continues to cast a pall over the real estate market with higher mortgage rates and decreased inventory keeping prices artificially high.
One potential solution to the dilemma would be if the Federal Reserve reconsidered its 2% inflation target. Raising that to 3% or higher would end the ongoing cycle of rate hikes. Barring that, a recession in which home values decline would make housing more affordable for a wider range of people.
Notwithstanding either of those two scenarios, the residential and self-storage subsectors should continue to benefit from the present economic climate.
Weekly REIT Report: REITs are one of the most misunderstood investment options, making it difficult for investors to spot incredible opportunities until it's too late. Benzinga's in-house real estate research team has been working hard to identify the greatest opportunities in today's market, which you can gain access to for free by signing up for the Weekly REIT Report.
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