“How the Fed’s Rate Hikes Impact Boston’s Housing Market”

Courtesy of Boston Magazine

Americans have been feeling the effects of the Federal Reserve’s interest rate hikes since March 2022. Designed to tamp down rising inflation, the heightened rates have since trickled down into various sectors of the American economy. One of the most prominent examples of the effects are the exorbitant increases in rates within the housing market.

The standard 30-year fixed mortgage as of September 2023 is at 7% – up from 6% a year earlier, and 3% two years earlier. In July 2023, it was calculated that the median American household needed about 44% of its income to cover annual payments on their median-priced homes- the highest level since 2006. Within the Boston metro area, rent prices have jumped as high as 25% over the past year.

What led to these dramatic increases? While the Fed’s increases of the federal funds rate do not directly raise housing rates, the federal funds rate does have an impact on investor expectations and demands. If these expectations err on the side of pessimism, they can be detrimental to the housing market. When the Federal Reserve raises rates during a period of high inflation, it does so in order to incentivize saving rather than stimulate spending. Historically, this has helped to slow down the rate of increasing prices (inflation).

If investors expect inflation to continue, they may choose to put their money into safer investments, such as mortgage-backed securities (MBS). An MBS is a collection of mortgages that have been gathered and organized to pay out interest similar to that of a bond. Lenders seek to continue to appeal to investors during times of inflation-where returns on investment are normally lowered-by utilizing higher yields. These elevated yields therein impact mortgage owners through increased mortgage rates.

As a result of these higher mortgage rates, many who would consider putting their homes up for sale are less likely to do so because of the higher cost of financing a new home. Would-be-sellers have more recently chosen to continue to pay their current mortgages rather than take on the new rates associated with a new home purchase. This presents another problem for buyers- less homes on the market.

This leads to a real-life example of one of the most basic economic principles: supply and demand. Increased competition amongst buyers is a resulting consequence of the smaller pool of homes for sale. The ensuing competition leads to multiple bids on homes, which often equates to sellers receiving prices that greatly outpace their asking price. The sold-to-list price ratio (the ratio that compares the price that a property is sold at to the original asking price) exceeded 100% for a fourth consecutive month in July 2023. In May 2023, the median price of a single-family in Boston home rose to an all-time high of $900,000.

Even with a lucrative sold-to-list ratio, many homeowners are still unwilling to list their properties for sale, resulting in active listings of single-family homes to decline by 30% from 2022 to 2023, and condominium listings to decrease respectively by 20%. Rental units haven’t escaped price increases, either. Boston has had some of the highest escalation in rent, with a 25% increase since 2021.

With the median housing price at an all-time high, a lack of supply, and skyrocketing rent, both economists and politicians have deliberated a plethora of potential solutions to mitigate the effects of this crisis.

Boston mayor Michelle Wu, a longtime proponent of rent control, has sought to put a cap on rent increases. Wu’s plan would include a cap that sets annual allowable rent to increase at 10% or at the consumer price index level for Boston plus 6% depending on which rate is lower. The mayor’s proposal would exempt new buildings for 15 years, as well as universities and owner-occupied homes with six units or fewer. Wu’s plan would seek to upend a 1994 ban on rent control in the state of Massachusetts. So far, the mayor’s rent cap has not fared well, with a majority in the state legislature voting to block her proposal.

Opponents of rent control point to how it has historically led to many unforeseen long-term consequences, including an inability for landlords to afford the costs associated with property upkeep, incentives to build luxury apartments as opposed to more affordable housing, and a misallocation between tenants and the size of the rental units that they occupy. Representative Mike Connolly (D-MA) has filed a ballot petition measure in order to allow voters to decide on the issue of implementing rent caps.

With the Federal Reserve hinting at raising rates once more before the end of the year, it seems as if this dilemma is far from over.