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2022 Economic Outlook: Take the Good With the Bad

Investors and move-up buyers will keep home sales humming, but inflation and other issues could be hurdles. 

Winter 2022

Key Takeaways:

  • Mortgage rate increases will hamper housing affordability in 2022. 
  • Current homeowners may find themselves ‘mishoused' as a result of the pandemic and seek out new lifestyle choices.
  • Commercial real estate remains strong, though the office sector can expect rent concessions to continue in 2022. Tax incentives or extra government funding may be needed to repurpose underused office space.

“It was the best of times, it was the worst of times ... it was the spring of hope, it was the winter of despair.” Those are the words of Charles Dickens in A Tale of Two Cities as he described the times surrounding the monumental French Revolution.

The times right now feel like something of a revolution.

Yet, there is more wealth accumulation in the country than ever before. Despite some volatility, the stock market hit new highs last year, and home prices consistently increased. Americans’ total net worth rose by $31 trillion between the onset of the pandemic and the middle of 2021, the largest hike ever in an 18-month period.

“Investors may have looked to the past to find that real estate is a very good hedge against inflation.”

Housing Shines Bright

Home sales are at their best in 15 years. Once all the data are tallied up, more than 6 million existing homes and about 800,000 newly constructed homes will have been sold in 2021—the best performance since 2006. Sales in recent months have been a bit lower compared with the same period last year, when we experienced intense bidding wars. Still, 2021 will finish meaningfully higher than 2020, which was affected by the spring pandemic lockdown.

The pandemic boosted housing demand as people sought larger homes in less crowded areas. But the magical power of low interest rates played a greater role, as it always does. Mortgage rates averaged 3.9% in 2019 but have hovered near 3% since the onset of the pandemic, helping to lower monthly mortgage payments. That interest rate drop represents about $150 per month in savings for buyers with a $300,000 loan, reducing the monthly payment from $1,415 to $1,265.

However, affordability conditions are changing. Home prices have increased by 25% since March 2020. The $300,000 loan now turns into $375,000. Even with low interest rates, the monthly mortgage payment shoots up to $1,581. The initial relief brought by lower interest rates is wiped out by higher prices, especially impacting first-time buyers. That’s why first-time buyers now account for less than 30% of home sales, down from 35% in the early months of the pandemic.

Rising Rates, Inflation Pose Challenges

That is not the end of it. Mortgage rates are set to rise this year. The Federal Reserve has been in a quandary about which of two mandates it should focus on: full employment or manageable inflation. Four million fewer Americans are working compared to before the pandemic. The unemployment rate, though it’s back to normal levels, is a less important measure because those who are not searching for a job are not counted. So, the Fed should be accommodative to keep pushing the economy along. But the highest core inflation in 30 years is forcing the Fed to rethink its approach. Reducing the purchase of mortgage-backed securities and raising short-term interest rates are inevitable. The end result of these policy actions will be higher mortgage rates, around 3.7% by the end of this year. At that rate, a $375,000 loan will translate to a $1,726 monthly payment.

The Fed’s inflation-fighting policies won’t contain rising costs immediately. Inflation will be with us throughout 2022. In addition to higher housing costs, meat prices have gone up by 12% as of November and gasoline prices by 50%. Perhaps, this is a hint to eat more veggies and fruits (which have risen in price by only 3%) and buy electric cars. Real estate professionals need to drive more than the general population and will not be happy about high energy prices.

Rising apartment rents have boosted multifamily property prices. This may be why more investors are buying single-family properties. Home purchases for reasons other than primary occupancy rose to 17% of all transactions in October. Moreover, some investors may have looked to the past to find that real estate is a very good hedge against inflation. In the 1970s, when inflation was high, consumer prices rose by 7.1% on average per year. Home prices outperformed consumer prices with an average 9.9% annual gain. In the 1980s, as the Fed jacked up interest rates in order to kill inflation, home sales plunged—but not home prices, because rents were rising. During that decade, consumer prices and home prices rose by 5.6% and 5.5%, respectively. In subsequent decades, it was the same story: Home price growth has roughly matched or slightly outperformed consumer price inflation.

The combined impact of investor purchases and repeat buyer transactions will buoy home sales in 2022, even with rising mortgage rates. Existing-home sales are expected to fall by only 2% after a nice 14% cumulative growth in the past two years. Home prices will not fall and, in fact, will rise by 4% nationally.