Mind the Supply: The Counterintuitive Impact of Higher Rates on U.S. Housing

The dearth of homes for sale has underpinned the housing market’s surprising resilience and may further lift home prices despite reduced affordability.

Rather than causing home prices to tumble, the sharp rise in mortgage rates over the past two years has bolstered the U.S. housing market by curbing the supply of homes put up for sale. That supply-demand imbalance is likely to continue, in our view, supporting further home price appreciation and rental inflation.

Several factors have constrained supply, including the "lock-in effect" by which homeowners with low mortgage rates are reluctant to sell to buy another home at a much higher rate. We believe this effect will persist. The construction of multifamily housing is also expected to decrease over the next few years, exacerbating the housing shortfall.

We are monitoring several gauges of incoming housing supply for signals about market health. PIMCO sees attractive opportunities in bonds backed by residential mortgages, given our expectation that home price appreciation will remain resilient. We believe U.S. home prices could rise by low double-digit percentages in total over the next three years in the current higher-rate environment.

Higher rates act as a supply constraint

U.S. housing market dynamics have changed drastically since the start of the pandemic, when monetary stimulus pushed mortgage rates to historic lows, spurring a wave of home purchases and refinancings. In subsequent months, fiscal stimulus supported the U.S. economy while Americans broadly reconsidered where they wanted to live and work, leading to unprecedented home price surges in many areas.

Since then, the Federal Reserve has hiked interest rates steeply to fight inflation, and mortgage rates have spiked to 20-year highs. With home affordability sharply reduced, mortgage purchase applications have fallen to historic lows. The seasonally adjusted annual rate of existing home sales fell to 3.79 million in October, from a pandemic peak of 6.5 million, according to the National Association of Realtors. We expect a further decline to about 3.5 million to 3.75 million.