“Stay alive to ‘25,” advised Susan M. Wachter a year ago.
The Wharton real estate and finance professor predicted that the 2024 real estate market would be better than the “extremely painful” 2023 one. Wachter, also the co-director of the Penn Institute for Urban Research, suggested waiting for better times in 2025.
In December, Wachter appeared on the Wharton Business Daily radio show on SiriusXM to share her insights on the outlook for 2025, forecasting “muddy waters ahead.” She noted that though 2024 did bring some happy tidings, the real estate industry “just survived” the year.
Pointing to the Federal Reserve Bank of Atlanta’s GDPNow latest estimate, she commented, “The big surprise of 2024 is this incredible GDP grown on all cylinders,” and added that it “is far higher than anticipated.”
The strength in GDP growth is affecting demand, inflation expectations, and predictions about rate decreases. Residential real estate is already experiencing a supply and demand crisis with no end in sight, and it is caught in the aftermath of those fresh trends.
Mortgage Lock-ins Haunt the Market
Along with strong economic growth, “inflation has come back,” Watcher said. This will affect the 10-year Treasury rate, “and the mortgage rate even more,” she added about the latest estimates.
The so-called mortgage lock-in effect occurs when households have a cheaper mortgage of 3%, 4%, or 5% than the current 6.8% 30-year mortgage rate and opt to stay in their homes. Wachter noted that because many households have mortgage rates of less than 4%, the housing supply will remain constrained into the foreseeable future. However, this will change, she explained, if the inflation rate declines sufficiently to lower mortgage rates, making mortgage lock-ins less attractive. Then, the housing supply could significantly increase.
“If interest rates and mortgage rates fall a bit more, they’ll be able to make more deals,” Wachter said.
The share of total purchases coming from new construction is at a high percentage as home builders attempt to meet the supply gap, especially with more price-sensitive homes to match the market’s demand. The usual equation is that newly built homes are priced higher than existing homes, but this is changing to meet the market.
“Housing prices are converging, which reflects the fact that home builders are building to demand,” Wachter said.
Builders must do this to counteract buyer resistance to housing prices they consider too high. This has affected their profit margins, which are only worsened by higher input costs.
“[Builders] are having a hard time getting affordable product [to market]. But they’re trying to get affordable product out, and they’re doing a pretty good job of it,” Wachter said.
Offering financing at lower interest rates is another way home builders are incentivizing deals.
Rentals Are Offering a Temporary Solution
Multi-family rentals have emerged as a solution to ease the challenges of the housing supply and affordable prices.
“In the rental market, supply is up such that we are seeing rent relief,” Wachter said.
Rent has fallen in some Southeast markets, and there is an oversupply of rental housing in places like Austin, Texas. Additionally, rent levels are flat on average in newly built houses. Wachter notes that this could change in the future.
“The supply is more than sufficient right now, but the demand is so high that that supply may be absorbed in a year or two, and we’ll start seeing rents go up again,” Wachter said.
The biggest challenge continues to be increasing the supply of existing homes, which would relieve the market since those account for most housing transactions.
“[Revival of housing markets will] happen when we have the big picture issues dealt with, which are interest rates, mortgage rates, and inflation expectations under control,” said Wachter.
