Why Interest Rates Effect Inventory Levels

Why are home inventories remaining so low in 2023? The interest rate is partially to blame. As you probably already know, your existing mortgage interest rate doesn’t travel with you when you purchase a new home. Many homeowners don’t want to give up their lower rates by jumping houses. As a result, “home hoppers” who usually free up inventory are staying put instead of moving on. This is creating an especially painful situation for buyers looking for classic “starter homes” that represent the smallest and cheapest properties.

The Math Behind High Interest Rates and Low Inventory

While soaring prices make the idea of cashing in tempting for many homeowners, those gains can quickly be eaten up by interest rates that could be as much as double compared to just two to three years ago. Higher mortgage rates can easily add hundreds of dollars a month for buyers on top of what are already record home prices.

When current owners don’t sell, both first-time buyers and “upgraders” have fewer homes to choose from on the market. As the 2023 summer buying season heats up, the interest rate on a 30-year mortgage stands at 6.67%. While this represents a month-to-month slide, rates are still significantly elevated compared to this time last year.

In addition to the generic answer of “high interest rates” to explain the thin housing inventory, it’s important to look closely at the nuanced reasons behind the continuously dwindling supply. First, many older Americans are making the decision to age in place instead of giving up their homes. This is driven by a rise in home-based healthcare and assisted-living services. It’s also being fueled by the fact that people who have paid off their homes are reluctant to risk those high home prices and interest rates that are making homeownership so difficult for younger buyers today.

“While the overall housing market has cooled nationally, the housing supply gap from slow construction that followed the Great Recession continues to influence a potential homeowner’s ability to buy a home,” according to Realtor.com. With national inventory below the “comfortable spot” of 1 million as the market entered the busy spring buying season, it was bound to be a summer of competition for buyers. While inventory did rise 13% on a year-over-basis at the start of March, it was still down 30% compared to five years ago. By May, the national inventory had 22.7% fewer homes newly listed for sale compared to the previous year. While homes in May lingered for an average of 43 days on the market to overtake the 29-day average from 2022, this is still much shorter than the pre-pandemic average.

A second factor contributing to low inventory is the rise in investor activity. Many larger investors are paying cash for homes. Those that are financing homes often have the means and backing to cover higher interest rates.

“Investors bought 24% of all single-family houses sold nationwide last year, up from 15% to 16% annually going back to 2012,” according to one analysis. The states with the highest investor activity are Georgia (33%), Arizona (31%), Nevada (30%), California (29%), and Texas (29%). As you’ll see next, even cities that aren’t necessarily investor hot spots are still seeing the squeeze.

Inventories in Metro Markets Are Hitting Record Lows

Metro areas are experiencing greater housing shortages compared to rural areas around the country. According to a recently published report by TIME, the metro areas around the country with the lowest inventories are Rochester, Buffalo, Allentown, Grand Rapids, Worcester, Greensboro, Hartford, and Boston. While these cities may fly under the radar in terms of being hot markets, they provide great examples of how densely populated towns combined with a lack of new constructions can create serious housing crunches. A usually “cool” market like Hartford has seen a huge increase in buyers who have been priced out of markets in New York or New Jersey. This is one of the reasons why builder-friendly markets near Austin, Dallas, and Nashville are expected to cool down from a period of bidding wars as more inventory eventually hits the market.

The Bottom Line on Interest Rates and Inventory

There’s no forthright answer coming from the Federal Reserve about when interest rates are coming down. Once rates do begin dipping, the descent is likely to be slow. That means that the market may remain in an internal stalemate for quite some time until sellers feel more comfortable unloading their homes. It’s possible that sliding home prices will cause some sellers to capitulate out of a fear that they’ll miss this upswing in the market if they don’t sell before the next “crash.” However, that may not be enough to actually create the kind of inventory needed to conjure up anything resembling a buyer’s market.