[Financial Planning for the 100-Year Life] Do House Prices Fall Only When Interest Rates Drop?

Despite the U.S. Federal Reserve (Fed) raising interest rates, housing prices have increased. If interest rates fall in the future, housing prices may decline.

The Fed raised the federal funds rate from 0.00-0.25% in February 2022 to 5.25-5.50% by July 2023 and has maintained that level until August 2024. The 30-year fixed mortgage rate also surged from 3.6% in February 2022 to 7.8% in November 2023. Since then, it has remained at a high level around 7%. Nevertheless, nationwide U.S. housing prices rose by 10.1% between February 2022 and June 2024.

The factors behind the rise in housing prices can be found in both demand and supply aspects. First, on the supply side, there has been a decrease in housing supply. New home sales in the U.S. peaked at 460,000 units in October 2022 but dropped to 410,000 units by May this year. Rising raw material costs increased construction expenses, and higher interest rates led builders to reduce home construction relatively. The decline in existing home sales was even more significant. In June this year, existing home sales fell sharply to 3.9 million units, reaching levels seen during the 2008 financial crisis when the housing bubble burst.

The reason for the decline in home sales is the rise in mortgage rates. According to Wells Fargo, a major U.S. bank, over 80% of homebuyers obtained loans at rates below 5%. Since U.S. households must take out loans at higher rates when selling their current homes and buying new ones, the supply of existing homes decreased, causing housing prices to rise.

On the demand side, housing demand inevitably contracted. Household income did not increase enough to comfortably afford home purchases. U.S. housing prices rose 141.7% from the low point in March 2012 to June this year. However, during the same period, household disposable income increased by only 69.8%. This means housing prices rose about twice as fast as income.

Both supply and demand for housing decreased. However, the supply reduction was larger, causing existing home sales volume to fall to pre-2008 financial crisis levels while housing prices increased.

As the lagged effects of interest rate hikes appear, consumer spending growth is slowing, inflation is decreasing, and employment growth is also slowing. The personal consumption expenditure inflation rate (year-over-year) was 7.1% in June 2022 but dropped to 2.5% in July this year. Inflation is expected to approach the low 2% range after September.

Employment growth is slowing. Nonfarm payroll employment increased by 114,000 in July, a significant slowdown compared to the 2023 monthly average of 251,000 and 218,000 in the first half of this year. The unemployment rate rose from 3.4% in April last year to 4.3% in July this year. The Fed is expected to cut the benchmark interest rate at the Federal Open Market Committee (FOMC) meeting on September 17-18. The Fed may even implement a 'big cut' of 0.5 percentage points due to concerns about declining employment.

Reflecting the anticipated rate cut, mortgage rates recently fell to 6.3%, and they are expected to decline further if the Fed lowers rates. This would encourage builders to construct more homes, and households would be more willing to sell existing homes to move to better living environments. Demand will also increase as interest rates fall. Future housing prices will depend on supply and demand. Since housing prices are high relative to income, supply is more likely to increase than demand. This would lead to increased housing transactions and a decline in prices.

In South Korea, there have also been cases where housing prices rose when interest rates increased. An analysis of data from January 2015 to August 2024 shows a positive correlation (correlation coefficient of 0.33) between the Bank of Korea's benchmark interest rate and apartment prices. This means that interest rates are not the sole factor determining housing prices, and if interest rates fall, housing prices can also decline.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University

This content was produced with the assistance of AI translation services.