Part 2: Interest Rates are Surging; Is the South Bay Home Market Set to Cool?

The hottest topic in residential real estate right now: Interest Rates!

It is such a trending topic that not only did I devote a full post to it last week, but also I am also writing a redux for this week! There is a lot to unpack from a data standpoint, along with anecdotal evidence and my own subjective opinion.

If you missed last week’s post, I suggest you read it here: “Interest Rates are Surging; Is the South Bay Home Market Set to Cool?”

This will allow you to more deeply understand how interest rates have affected California real estate prices in the past.

Spoiler Alert – Below is a quick Cliffs Notes from last week’s blog post…

• There is ZERO correlation between mortgage rates and California home prices.
• Interest rates are just one factor in at least 10 important factors to consider.
• More than ever, demographics shifts are likely to dictate the market’s future.

Short bullet points do not do the post justice! Please read it and I promise you will be more informed on residential real estate.

The link is here one more time for reference: “Interest Rates are Surging; Is the South Bay Home Market Set to Cool?”

So, now that you have hopefully read part one of my interest rate essay, let’s begin with part two for you to consider.

Look Beyond the Headlines

Our society loves to read headlines; it seems we do not like to read much beyond those headlines anymore.

I saved an April 6, 2022, CNBC.com article from their residential real estate reporter, Diana Olick, titled: “Surging Interest Rates Push Mortgage Demand Down More than 40% from a Year Ago.”

That headline is ominous.

If you read just the headline, you would assume higher mortgage rates are destroying demand and the market is inevitably cooling.

Let’s stop just reading headlines. I’ll dive even deeper for you.

This is the scary data:

• Average 30-year fixed mortgages are 4.9% today vs. 3.36% last year.
• Mortgage volume is down 40% that week year-over-year.
• Refinance applications demand plummeted by 62% from a year ago.

That headline is scary and the article’s early main points are terrifying.

If you take the time to unpack the numbers and think about what matters to our South Bay home market and beyond, then you came away with some important information.

• “Mortgage applications to purchase a home declined 3% for the week and were 9% lower than the same week one year ago.”

While mortgage applications are an inexact science to gauge demand, the above quote is valuable to focus on.

A year ago, in April 2021, the market was taking off with increasing prices and multiple offers. Today, prices are 10% to 20% higher and interest rates are a full 1.5% higher.

Those are some major headwinds for buyers. And, only 9% of applications were lost.

To put that in perspective, if you applied the above effects to a Hermosa Beach home buyer, the difference is a $180,000 higher price and their payment that goes from $6,954 a month to $9,128 a month.

So, the monthly mortgage cost to own that same home jumped 31%!

And we only lost 9% of buyers?

This could be a lagging indicator, but I would think the market would lose a lot more considering the sharp loss in buying power from just 12 months ago.

Purchase Applications vs. Inventory

If you read through the headlines, you saw that the majority of the decline in mortgage origination was due to refinance volume, not purchase volume which is the demand part.

Duh! Anyone who needed to refinance has done so over the last two years. Refinances are dead at 5% rates.

Now, let’s take the purchase application volume a step further. If we can assume that demand has dropped by 9% since last year, then how does it compare to inventory levels?

Cue my first quarter blog if you have not read it and check the inventory section: “Scorching Hot Q1 South Bay Home Numbers to Start 2022”

Scroll to the bottom of the post and let’s sample inventory (aka Active Listings):

• Manhattan Beach with 52% fewer homes for sale
• Palos Verdes Estates with 54% fewer homes for sale
• Redondo Beach with 39% fewer homes for sale
• Rancho Palos Verdes with 20% fewer homes for sale

You get the point.

While mortgage purchase applications fell by 9%, those buyers faced incredible headwinds of increasing prices and significantly higher rates (as stated above).

What’s more, inventory fell to even lower levels year-over-year and significantly outpaced the 9% lower demand.

It is still a seller’s market and perhaps even more so today, even if buyer demand is slowing slightly. The demand is not slowing fast enough compared to squeezed inventory in the South Bay.

Few Motivations to Sell

And finally, the last section here that highlights few motivations to sell due to interest rates, which in turn, are unlikely to solve the inventory problem.

There are three data-points highlighted by respected national entities worth highlighting:

• A national housing survey conducted by Fannie Mae found that 92% of current homeowners, regardless of income level, believe that their home is somewhat or very affordable.

• According to Redfin, more than half of current homeowners were able to lock in a rate below 4%.

• And lastly, data from Black Knight reports that nine out of 10 mortgages carry an interest rate of less than 5%.

So, what does this information tell us?

The title of this section blows it, but yes, there are fewer motivations to sell.

If you have owned a home for longer than two years (shoot, even just 12 months), prices are higher by at least 20% and your new borrowing costs have sky-rocketed due to rising rates.

Psychologically, nobody wants a higher interest rate than they already have.

How that relates to the South Bay home market is likely bad news for home supply.

A large majority of South Bay homeowners would have to pay significantly higher prices than what they paid in the past, as well as take on an interest rate 1%, 2% and in some cases 2.5% higher than they currently enjoy.

As mortgage rates rise, along with prices – I believe we are seeing greater incentive for owners to KEEP their homes.

For sale home inventory might go lower as prices/rates increase.

Bottom Line

I want you to take the information this week, along with the post from last week, and come to your own conclusions!

From my perspective, the headline news stories sound downright terrifying, but it is far from that bad.

Purchase mortgage applications are down 9% year-over-year, but inventory is down 20%, 40%, and even 50% in some of our local South Bay markets over the same time.

Buyers’ monthly mortgage costs are up 31% and higher down payments + property taxes are a real issue – one would think demand would be dropping even more significantly.

And finally, the self-fulfilling prophecy that no one likes to pay higher interest, which in turn, disincentivizes owners to sell their homes when the next home will be more expensive and carry higher borrowing costs.

This market is SO MUCH MORE than rising interest rates.

There is zero correlation between interest rates and California prices historically. Inventory is at all-time lows, while demand is still strong. Demographic shifts will continue to put pressure on the supply/demand imbalance. And, higher interest rates may hurt demand, but it might disincentivize new supply even more.

You be the judge.

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• 925 9th Street, Hermosa Beach
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