Corporate insiders are signaling a potential decline in mortgage rates, which could lead to a resurgence in housing turnover. This development holds promising implications for home buyers, housing-related companies, and investment vehicles tied to the housing market.
Mortgage Rates on a Downward Path
Mortgage rates are largely influenced by the yield on the 10-year Treasury (BX) plus a risk premium. A significant component of this premium compensates lenders for prepayment risk, which occurs when borrowers refinance at lower rates during times of interest rate volatility. Currently, the spread between mortgage rates and the 10-year Treasury yield has widened to about 2.75 percentage points, far above the typical 1.5 to 1.75 percentage points.
Moody’s Analytics Chief Economist Mark Zandi highlights the heightened volatility in interest rates due to uncertainties around inflation, recession, and Federal Reserve rate decisions. This volatility has pushed lenders to increase the risk premium. However, as inflation declines and the Fed begins to cut rates, interest rate volatility is expected to decrease. This reduction in volatility would likely narrow the spread back to its historical average, potentially bringing mortgage rates down to around 6%.
While a 6% mortgage rate may seem high compared to recent historical lows, it would likely stimulate the housing market. Zandi predicts that more realistic expectations around mortgage rates will encourage home buyers to re-enter the market, increasing housing turnover.
Inflation’s Role in Reducing Interest Rate Volatility
A key factor in the anticipated decline in mortgage rates is the ongoing reduction in inflation. As inflation continues to fall, bond market fears will subside, leading to Federal Reserve rate cuts. This, in turn, will stabilize the bond market and reduce the risk premium associated with mortgage rates. According to Zandi, clearer signals from the Fed regarding rate cuts will moderate bond market volatility and lower prepayment risk, normalizing the spread between fixed-rate mortgages and the 10-year yield.
Drivers of Increased Housing Turnover
Several factors are poised to drive an uptick in housing turnover. Potential buyers have substantial cash reserves, with U.S. money market funds holding approximately $6 trillion, providing ample liquidity for down payments. Millennials are reaching life stages where they are forming households, mirroring demographic trends of the Baby Boomers in the 1980s, which will bolster housing demand. Many homeowners, especially Boomers, need to downsize or relocate due to evolving lifestyle needs, driving housing market activity. The push for employees to return to office work, even part-time, may prompt those who moved further away during remote work periods to relocate closer to their workplaces. Additionally, with housing turnover at historically low levels, any reduction in mortgage rates could trigger significant market activity, as last year saw only 4.09 million homes change hands, the lowest since at least 2005.
Investment Opportunities in a Rebounding Housing Market
Investors can capitalize on the potential rebound in the housing market through various avenues:
Zillow Group (Z): This comprehensive real estate platform benefits from increased housing activity by providing services ranging from home listings and virtual tours to mortgage origination and title services. With a 13% rise in first-quarter revenue to $529 million, Zillow’s focus on solving consumer problems with innovative software positions it well in the current market. Insider buying, including board member Jay Hoag’s recent $100 million stock purchase, underscores confidence in the company’s prospects.
RH (RH): The upscale home furnishings retailer has seen significant insider buying, with CEO Gary Friedman acquiring nearly $10 million in stock. As housing activity picks up, demand for home furnishings is likely to rise, benefiting RH.
Mortgage-Backed Securities (MBS): Actively managed mutual funds and ETFs specializing in MBS can offer exposure to this asset class. As interest rates decline and housing turnover increases, the value of MBS is expected to rise, presenting a compelling investment opportunity.
Conclusion
The anticipated decline in mortgage rates and subsequent rise in housing turnover present a promising outlook for home buyers and investors alike. With inflation falling and the Fed poised to cut rates, the resulting reduction in interest rate volatility will narrow the spread between mortgage rates and the 10-year Treasury yield. This shift will likely rejuvenate the housing market, creating opportunities for investment in housing-related companies and financial instruments.