Outlook of Interest Rates for 2023

Multiple factors have come into play concerning the commercial real estate market in 2023; which include, but are not limited to, supply chain disruptions and inflation. Even though the outlook for the real estate market appears to be grim, experts believe that there will be positives to go along with the negatives in 2023. The Federal Reserve has increased interest rates during the summer season in 2022, but that should not sound the alarm for any long-term doom and gloom.

To get more insight on how interest rates could affect the real estate market in 2023, we need to understand how interest rates have any impact at all on this market.

The Impact of Interest Rates

Interest rates are always changing on a daily basis, and most of the time there is no way of knowing which direction they will go until after the fact. Keep in mind that interest rates do not have a direct impact on the price of a house. Here is one example: Interest rates may increase by 0.3% today, but then for the next three days straight those rates will drop by 0.1%.

No matter how minor the fluctuations are in interest rates, the price of a house that was put up for sale last week may stand firm at its original selling price of $300,000. However, when interest rates are changed dramatically, the general affordability of housing is impacted. If you had enough money to buy a home around the price of $300,000, you may be put into a position where you can only afford homes in the price range of $250,000 to $275,000.

2022 saw interest rates raised at least twice courtesy of the Federal Reserve’s Federal Open Market Committee (FOMC). The FOMC has stated that it is likely for Americans to see more increases throughout the remainder of the year.

How Rates Change Real Estate

Whenever interest rates increase or decrease, or if they remain static, it basically results in adjustments being made to the Federal Reserve’s monetary policy. If interest rates decrease, then that means the affordability of houses increases, which also means happier potential homeowners. If you qualified for a $300,000 home on the market at an earlier time, you may soon qualify for a $350,000 home should interest rates decrease. Demand in the housing market tends to grow when the interest rates are lowered, although lower rates can also be a reason why housing prices have increased throughout most of the country.

However, when interest rates are raised, affordability is negatively effected. If a buyer previously qualified for a $350,000 mortgage at the end of one year, that buyer may now only qualify for a $327,000 mortgage due to raised interest rates. When interest rates are raised, some potential buyers may see themselves priced out of the market.

The third side of this story happens to be static interest rates, which hinge on whatever the current economic environment is like. Do not assume that static interest rates uphold the status quo in the market, because that is rarely ever the case. Unlike interest rates, housing prices and activity do not stagnate when the FOMC upholds its monetary position. For most of the last decade the FOMC has kept its rate below 1%. Consider that immediately after the FOMC slashed rates during the Great Recession in 2008, housing prices in many parts of the country trended downward due to the market crash.

What the Numbers Say

Capital Economics projects that home prices will decline around 5% by the middle of 2023. The firm does not expect a complete crash in the market, as its current projections call for values to quickly rebound and post an annualized increase of 3% by 2024.

According to the Federal Reserve Bank of St. Louis, the median selling price of American homes was an estimated $428,700 through the first quarter of 2022.

One group that does economic research and surveys, called Capital Markets, says that housing prices will drop in 2023. This is partially due to increasing inflation in the economy, as the interest rates of loans, which is the general cost of borrowing a loan, will increase. The end result of increased loan rates is that much fewer people will be able or willing to apply for loans. This explains why the cost of buying homes will steadily decrease.

Capital Markets also states that the number of visits to real estate property websites have decreased in 2022, and that trend is expected to continue in 2023. This can be viewed as a clear indication that the housing market is turning, and the solution is to typically lower house and home costs to compensate.

Seller activity is positioned to increase in 2023 because sellers have more of a willingness to sell their properties. Perhaps one of the reasons for this is inflation, but on the flip side, buyers may remain reluctant to buy property due to the combination of higher interest rates and the added difficulty to obtain loans.

Investment firm Morningstar takes an optimistic stance as they believe that interest rates could potentially fall to 1.75% by the end of 2023. Morningstar expects inflation will slow down and the Federal Reserve will reduce rates. The broad expectation is that economic inflation will reverse course, and that deflation will occur by the end of 2023. Morningstar concludes in their report that while there may be a more delayed recovery in economic activity, there is reason to be optimistic about long-run GDP growth.

First-Time Buyers Will Have Challenges

It is also important to consider that the number of houses that are being put on the market has gone up in 2022. Many of these homes are in the expensive home category. While there are more choices for homes on the market now, first-time buyers will have challenges. These aforementioned homes in the expensive home category have seen their median value increase in the past year.

The increased seller activity coupled with buyer hesitancy can potentially lead to what is called a “housing glut”, which is already being experienced in some parts of the United States in regards to renting space. In summary, there will be more houses available for sale and rent than the number of potential buyers willing to invest in such properties.

There may be a decreased demand for houses because of issues relating to affordability, but the market is currently positioned to continue being competitive. Zillow says the main reason for this is those who want to upgrade by getting a better house will help keep the market competitive. Although the housing market is slowing down, in their regularly updated forecasts, Zillow expects to see a 2.4% increase in the value of the average American home through the end of July 2023.

Rising Mortgage Rates Will Slow

The National Association of Realtors (NAR) predicts that the 30-year average mortgage in 2023 will be  in range between 5% and 5.5% throughout most of the coming year. According to the NAR’s chief economist Lawrence Yun, the mortgage market has already taken into account all the possible rate hikes imposed by the FOMC, and that mortgage rates are expected to stabilize around the 5.5% mark entering 2023.

Any concerns that mortgage rates will skyrocket are generally not shared by the majority of mortgage industry experts. That includes the Mortgage Bankers Association, which expects rates to average around 4.8% by the end of 2022 and to decrease to around 4.6% by 2024.

The MBA also reports that its Purchase Applications Payment Index (PAPI) has seen fluctuations in 2022. If the PAPI increases, then that indicates declining borrower affordability conditions, which means that the mortgage payment to income ratio (PIR) will be higher due to increasing application loan amounts, any decreases in earnings, or rising mortgage rates. According to the MBA’s research, the top five states with the highest PAPI were Idaho (264.2), Nevada (254.6), Arizona (240.2), Utah (217.3), and Florida (211.6).

However, if the PAPI decreases, then that indicates borrower affordability conditions have improved. This happens whenever application amounts decrease, mortgage rates decrease, or if there is an increase in earnings. The one district and four states that had the lowest PAPI were Washington, D.C. (103.1), Connecticut (108.2), Alaska (115.4), West Virginia (118.5), and Louisiana (119.0).

Conclusion

It is important to pay close attention to what groups, such as professional economists and investment firms, are saying when they make predictions on interest rate changes. However, they can be, and have previously, been proven wrong. If you take American futures markets into account, which handles contracts between home buyers and sellers, then their report that interest rates will peak in January 2023 will carry a lot of weight.

It is equally important to stay vigilant on your part as either a buyer or seller in the real estate market, and to be mindful of when, how, and why interest rates change. Having prior knowledge of such changes can play a role in making or breaking real estate sales, and can give you the necessary leverage  during negotiations. After all, you should not have to pay more for your ideal home simply because of interest rate hikes if you can avoid the initial pitfalls.