Do Interest Rates Matter For Housing?
Will someone please tell me if interest rates matter for home prices? Conventional “wisdom” holds that low rates mean higher home prices, while high rates have the opposite effect. At first glance this is one of those things that makes perfect sense: The same mortgage payment translates to a larger loan value when rates are low. But how does this hold up under statistical scrutiny?
The answer shocked me. It doesn’t! In fact, history shows the exact opposite is true: Home prices tend to go up with interest rates:
- Post WWII – early 80′s. Home prices marched steadily higher despite a 30 year period of rising rates, and
- Early 80′s to 2008. Interest rates dropped off a cliff, yet home prices went to the moon!
Since our eyes can be wrong every now and then, let’s look to the regression results to gauge functional relationship. For those of you with bad memories of stats class, please forgive me:
What this tells me is that there is weak (R Square) linear relationship between home prices and interest rates. Weak though it is, the relationship is clearly positive (X Variable 1 > 0).
F value, significance F, and t stat for X variable 1 all point to this statistical relationship standing opposed to conventional wisdom.
With 60, or so, years of a conflicting story, let’s see if we can look at the data another way to see if there’s a better trend:
The scatter plot looks horrible, showing no relationship between changes in home prices versus changes interest rates. Even stranger, there’s a positive correlation in the data, as you can see by the coefficient to the X variable in the linear regression. Once again, conventional wisdom stands at odds with reality.
How Is This Possible? There’s two things I can think of to explain what we’re seeing. Either interest rates don’t matter as much as other factors in determining housing prices, and the correlation is merely coincidence; or, higher rates harbor, or are harbored in, conditions that favor housing.
The first case isn’t too difficult to imagine. There’s so many factors that can affect housing (personal income, general economic conditions, supply vs. demand, family formation, population growth, technological innovations like the automobile that enabled suburbia, etc.) that interest rate consequences can easily be lost in the mix. Maybe, if all other factors were held constant, we’d see a negative relationship to validate conventional wisdom.
The second case is more difficult to explain. Can high rates actually benefit housing prices? High interest rates provide incentive to save. More savings means healthier consumer balance sheets, better credit, and more equity to put down on a home. So higher rates should influence the relative mix between debt and equity capital, but it doesn’t necessarily have to influence total asset prices.
Things Are Different This Time! 5 scary words in finance! But one thing to consider is that the last housing boom was undertaken during a period of rapid, and potentially unsustainable credit expansion. So even though history doesn’t show us a clear negative correlation between rates and housing prices, we might surmise that the credit cycle may need to contract to reach a stable footing. If the current mix of home prices and savings levels require buyers to rely on mortgage debt that they might not be able to afford at higher rates, then we may finally see conventional wisdom meet reality.
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