As mortgage rates continue to rise, all eyes are fixed on the housing market for signs of a potential slowdown. But any slowdown that does materialize won’t affect the industry equally because it isn’t going to be about fundamental problems with the housing market. Rather, it will be the result of the Federal Reserve intentionally increasing borrowing costs to cool off inflation.

Lumber is cheaper, but not much else. Matt Rourke/Associated Press

ABOUT THE AUTHOR

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He has contributed to The Atlantic and Business Insider and lives in Atlanta.

The Fed’s efforts are happening in the context of a supply-constrained market where homebuilders have been struggling to complete as many homes as they would like. Any negative impact of rising mortgage rates would be felt disproportionately where affordability problems already are the worst – high-cost coastal markets – and then in materials for the early part of the construction cycle, such as lumber.

Understanding the nature of the housing challenge is important so that you aren’t tempted to compare the situation with past downturns. For now, at least, there is no broad industry downturn as we’ve seen before in oil and gas or the technology sector that would lead to the housing market suffering in places like Houston or the San Francisco Bay Area. Homeowners haven’t taken on too much debt, and there’s no inventory glut – quite the opposite, in fact – that would lead to a broad-based downturn.

What we’re seeing instead is that the surge in mortgage rates engineered by the Fed is adding to affordability problems. So it stands to reason that the places most affected will be metro areas that were already the least affordable. On the basis of house-price-to-income, the worst in 2021 were Los Angeles, San Jose, San Francisco and San Diego, so those would be the cities to watch.

In a report earlier this month, the housing website Redfin noted that since the first week of the year, tours of for-sale homes were down 21 percent in California compared with a rise of 23 percent nationwide, which may be a leading indicator of affordability issues starting to influence housing market activity.

There also is the post-pandemic migration dynamic of high-income households moving from high-cost to lower-cost areas. Home prices have soared in metros like Boise, Idaho, and Austin, Texas, over the past two years, putting homeownership out of reach for many local buyers. But for people moving from high-cost California, prices could still be affordable on a relative basis. That doesn’t mean Boise and Austin will be immune to a slowdown, but migration patterns could support those housing markets even as local buyers get priced out.

Another factor to consider: Even as home prices cool in some places, monthly payments will continue to rise. And if someone must pay an extra $200 a month in mortgage interest, that might mean the price of the home they can afford to buy must go down.

Mortgage rates will affect homebuilders’ calculations, too. For more than a year, builders have started more homes each month than they’ve been able to finish because supply-chain problems slowed construction. As a result, the number of homes under construction continues to grow, creating more risk for homebuilders if the market slumps just as the homes are finally ready to be sold.

Given all that, it would be reasonable for builders to reduce the number of houses they’re starting to match the number of completions and keep the pipeline from getting any larger. That would reduce risks to the builders in 2023 while still ensuring they have plenty of inventory to deliver over the next few quarters.

That would be bad news for materials and labor needed in the early phase of home construction, such as lumber and workers who specialize in framing homes. However demand for components needed at the end of the construction process such as windows, doors and cabinets should stay steady – and that’s been the source of supply bottlenecks that have delayed completions for months.

If there is any upside for buyers in the current market, it’s that because the affordability problems created by rising mortgage rates are intentional on the Fed’s part, they can always reverse those increases if it turns out they’ve overdone it to the point it threatens the economy. In the meantime, the coming months will give us the final answer on how buyers and builders respond to the surge in mortgage rates in this supply-constrained market.