December 11, 2023
Americans are only beginning to feel the impact of high interest rates
By 2024, residential property prices could fall by a further 15%
The construction sector will be affected, as in every crisis
Rental investment and real estate investment trusts remain unattractive

CHART OF THE WEEK: "It has become preferable to rent rather than buy"

Source : The Economist, Atlantic Derivatives


The rate hike is over. No matter how hard the Chairman of the Federal Reserve tries to convince investors otherwise, declaring that he is prepared to tighten monetary policy further if appropriate, the consensus on Wall Street is now firmly established. The stagnation of the US economy, the soaring unemployment rate, and the fall in the inflation rate to around 2% will force Jerome Powell to change his stance radically. Not only did the rate hike end on 26th July 2023, but the first cut could be made as early as 20th March 2024. In anticipation of this move on key rates, long-term yields have fallen sharply since 1st November.

The 10-year Treasury bond yield fell from 4.93% to 4.13%. Mortgage rates also took a step backwards, falling from 8.06% to 7.43% over the same period. This trend is likely to continue into the new year.

Despite this very good news, Americans will remain very cautious about the housing market in 2024. Firstly, the affordability index remains below the fateful 100-point threshold (see Fig. 2). In practice, at 93 points, this means that households have, on average, an income 7% below the minimum level needed to qualify for a mortgage loan to buy a standard home. This situation is unprecedented since the statistics were created 40 years ago.

Secondly, it is currently cheaper to rent than to buy. Between 2011 and 2020, monthly payments for tenants were 14% higher than for homeowners with a mortgage. This is no longer the case. Over the past two years, soaring house prices (+40%) and soaring mortgage costs (+50%) have completely reversed the balance of power. While nominal mortgage payments have more than doubled, rents have risen by 20%. Today, Americans have to spend 850 dollars more per month to own an apartment than to rent (see Fig. 3). According to The Economist, for 89% of Americans, renting is now cheaper than buying (see Chart of the Week). Three years ago, the figure was just 16%. To bring the situation back into balance, property prices would have to fall by 30%, average mortgage rates would have to fall to 3% or rental costs would have to rise by 50%. This will take time.

Thirdly, the rise in mortgage rates has not yet fully filtered through to the market. To understand this phenomenon, which is underestimated by analysts, it is crucial to remember that almost all Americans (90%) are indebted at a fixed rate, often for 30 years. This is considerably more than at the turn of the century, when only 74% opted for predictable repayments. As long as they are not forced to take out a new mortgage, households will not be affected by the rise in interest rates. Despite interest rates of 8%, more than four out of five mortgage holders are subject to a rate of less than 5%.

The effective mortgage rate is just 4% (see Fig. 4). The pace of increase is relatively contained, as some households refrain from moving house in order to keep their low-interest loans. It is only when they are forced to buy a new home as a result of a birth, death, divorce, layoff, forced mobility or any other life event that the new mortgage rate is applied. There is plenty of room for improvement in the effective rate in 2024. The hardest part is yet to come.

The divergence between the growth in sales of new homes and the decline in sales of existing homes is symptomatic (see Fig. 5). Millions of American homeowners, seeking to preserve their solvency, have decided not to sell their property. They cannot afford to give up the low mortgage rates they enjoy. As a result, the supply of existing homes for sale has literally plummeted and building new homes has become the easiest option for credit-worthy buyers.

This dichotomy in sales trends between new and existing homes should not mask the overall trend. As 85% of the residential property market is made up of existing homes, it is this market that really influences house prices (see Fig. 6). In 2024, annus horribilis, prices could fall by a further 15% (see Fig. 7). Against this unfavourable backdrop, the construction sector will see its order books shrink sharply. Companies will be forced to curb their investment spending and lay off some of their staff. Usually, there is a two-year lag between the loss of confidence among professionals in the sector and the wave of layoffs (see Fig. 8).

As long as the expected rate of return (cap rate) is so low compared with bond yields (see Fig. 9), there will be little appetite among investors to buy new rental properties. Similarly, real estate investment trusts (REITs) will continue to underperform their benchmark (see Fig. 10). Usually, it is not until the economic cycle bottoms out and prepares for a new expansionary phase that the sector does better than its benchmark. Distressed properties become available at lower prices, rental markets stabilise, and interest rates are low. Today, it is probably still too early for this.


The tightening of monetary policy is over, but its impact is not. On the residential property market, the effects of past rate rises will be increasingly felt in 2024. Demand for housing will be so weak that prices will fall by around 15%. For the trend to be reversed, interest rates will have to fall considerably and sustainably. On the one hand, to improve households' borrowing capacity and, on the other, to make rental property more attractive than bonds. Investors should continue to be patient before returning to this lucrative segment, whether directly or via the stock markets.

Return on financial assets