In this Monthly Market Trends series, we offer you our interpretation of current trends through the eyes of our VP of Market Risk, Patrick Donoghue, and provide you with his balanced commentary so you can make the best investment decisions today for the highest returns tomorrow.
Welcome to 2024!
Looking ahead to 2024, I would like to address two main trends.
First, I want to discuss interest rates and what the market expects. Second, I’d like to discuss the anticipated normalization of the housing market. These are the key factors to watch as we progress into a new year.
Literally central to any discussion of interest rates is understanding the position of Secretary Powell and the Federal Open Market Committee (FOMC) as a whole body. Thankfully, the FOMC releases its position every six weeks via the “dot plot”. The dot plot release provides a summary of the FOMC's collective view on the economy and the likely path of monetary policy based on the individual projections of its members.
Here's how the FOMC dot plot works:
Participants: The dot plot represents the views and projections of each FOMC participant. This includes the voting members (e.g., Federal Reserve governors and regional Federal Reserve Bank presidents) and non-voting members.
Time Horizon: The dot plot typically covers a specific time horizon, often including the current year and the next few years into the future. It provides a snapshot of the FOMC members' expectations for the economy over this time frame.
Interest Rates: The primary focus of the FOMC dot plot is to display each participant's projection for the federal funds rate, which is the interest rate at which banks lend to each other overnight. Each participant places a dot on a chart indicating their individual forecast for the future path of the federal funds rate.
Uncertainty: The dot plot also includes a range of uncertainty for each participant's projection. This range represents the degree of uncertainty or variability in their forecasts.
Here is the most recent December 2023 Dot Plot covering fed funds rate estimates through 2026 and longer:
Let’s follow the red dots (from left to right), which fall from 5.4 (the estimated terminal rate) in 2023 down and to the right through 2026 and longer. The red dot is the median participant assessment of where the Fed funds rate is estimated through 2026 and beyond. The median assessment plot is falling. And this is good news! The Fed Funds rate is the central rate for nearly all interest rates that affect us. It signals that inflation is well mitigated and that the economic factors that lead to historical increases in the Fed Funds rate are resolving.
There are numerous ways an easing central rate affects us as investors and providers of short-term real estate debt. Let’s examine them more closely.
- Interest costs to builders and flippers will likely decline, increasing profitability.
- Material costs of commodities necessary to build and complete projects will likely decline, increasing profitability.
- Labor markets may soften (the lagging result of a higher rate environment); fortunately, this can increase trade laborers' availability, significantly improving finish/delivery times and reducing overall labor costs.
- Mortgage rates are projected to be lower in 2024, helping spur demand, especially for newly built and renovated homes.
- The spread between the 10-year treasury yield and the 30-year mortgage rate will likely normalize from a peak of 3% close to the long-term average of 1.5%.
- Decreased rates may stem the tide of large homebuilder rate buydowns, which will help refocus buyers to well-executed renovations and smaller spec builder projects.
- The spread between LRO investments and “risk-free” investments like the two-year treasury will likely normalize, meaning the percentage points difference between the risk-free associated rate and LRO’s will increase.
While the dot plot from the December meeting provides an optimistic median trend estimate of rates moving forward, the dot plot is not static; it is dynamic, which means these estimates can and do change.
When in 2024 will the Fed Funds Rate likely begin to ease?
I don’t know exactly, but market participants who trade interest rates estimate this in a very readable format: the CME Fedwatch Tool.
For the sake of brevity, here is a table that shows how market participants estimate the probability of the Fed easing rates over the first six months of 2024*.
31 Jan 24
20 Mar 24
1 May 24
12 June 24
*as of 1/25/2024
The above table indicates that market participants estimate a 99.9% probability that the Fed will ease rates by June 2024. Clearly, the market expects easing.
Housing Market Normalizing
When I say a “normalizing housing market”, I am referring to a housing market where indicators return to a more typical level after a period of imbalance or volatility. We saw huge volatility in house price appreciation post-pandemic and a notable imbalance (lack of) housing supply following a historic run of monetary tightening in 2022 and 2023. How do we get back to normal or establish a new normal?
As stated, the lack of supply of homes was a central theme of the 2023 housing market. We clearly experienced a lock-in effect as potential sellers of homes with low-interest rates were hesitant to sell out of that preferable mortgage rate. Beginning this year, housing inventory is starting higher than in 2021, 2022, and 2023.
The inventory numbers at the start of this year support a positive trend for overall increased inventory for 2024 — an unlocking, so to speak, of the lock-in.
If homes are to be available, a basic question would be, “Will there be enough demand to support the supply?” Falling mortgage rates should boost demand as affordability comes back in line. In the final weeks of 2023 and the first couple weeks of 2024, as the mortgage rate fell from nearly 8% to the mid 6s, there was a noticeable increase in purchase mortgage application activity supporting the common sense notion that as rates fall, more buyers will purchase homes due the simple fact less interest means greater affordability.
The Mortgage Bankers Association detailed the application increase this way:
“Mortgage applications in the US rose by 3.7% on the week ending January 19th, marking the third consecutive increase in mortgage demand to extend the 10.4% surge in the previous week, which was the sharpest increase in one year. The data challenged the slight increase in mortgage rates in the period, as long-dated Treasury yields held their early-year advance amid heightened uncertainty over the Fed’s gradual monetary easing. Applications to purchase a new home rose by 8%, extending the 9% jump from earlier and offsetting the 7% decline in applications to refinance a mortgage.” – Source: Mortgage Bankers Association
Fannie Mae and the Mortgage Bankers Association predict mortgage rates will fall in 2024. Fannie Mae forecasts a 30-year mortgage rate to end the year at 6.3%, while the Mortgage Bankers Association forecasts a 30-year mortgage rate at 5.4%. Both forecasts support balance to the supply-demand of available units, which supports housing price stability.
Another benefit of a more normal housing market should be a higher rate of on-time completions for Groundfloor borrower projects, which means greater liquidity for your LRO investments and a higher rate of loan repayments by the maturity date. Here are some reasons to support a higher volume of Groundfloor loan repayments to investors:
- Material costs continue to improve, enhancing the feasibility of new and existing projects.
- Labor for new construction and renovation is more available, and labor costs are more reasonable.
- Demand in a decreasing rate environment will support purchases of newly built and well-renovated homes.
- The supply of capital from institutions for long-term rental financing will be more accessible in 2024, allowing more of our loans to exit using refinancing.
Further, affordable markets may see higher appreciation than those markets considered less affordable. Zillow sees these markets as the top housing markets for 2024.
*Methodology: The company said the ranking examines the nation's 50 most populous metros and takes into account Zillow's forecast for local home value growth and the speed at which home sellers are entering contracts with buyers.
Buffalo, New York may be a surprise, but it makes perfect sense as affordability across markets will most likely be the critical characteristic of how that market performs in 2024. Continuing on the longer term positive growth and appreciation trend, the South Atlantic regional cities of Atlanta, Charlotte, Orlando, and Tampa also made this top ten list. As I’ve written about in most posts in 2023, the Midwest continues to rank highly regionally in areas with stable and improving markets. In this list we see Cincinnati, Columbus, and Indianapolis.
This Zillow study supports loan growth in these areas, which also supports the Groundfloor portfolio of loans as there is a higher concentration of loans in the South Atlantic and Midwest.
Noted however is the functional importance of regions that offer highly affordable housing. This presents an opportunity for Groundfloor to further develop portfolio loan growth in cities/areas with advantageous price points and a positive housing demand outlook so that our investors can benefit from greater diversification in their portfolios at similar LRO rates.
No matter the skill level of the forecaster nor the prestige of the institution on whose behalf a forecast was made, we still maintain our prudence in understanding that uncertainty abounds. BlackRock distills uncertainty into risk categories and identifies potential events that have a probability of occurring. And of course, you have any number of Black Swan events that can take shape.
BlackRock Designated High Risk 2024:
- US-China strategic competition
- China takes military action against Taiwan or asserts claims by force.
- Major cyber attacks
- Cyber attacks cause sustained disruption to critical physical/digital infrastructure.
- Major terror attacks
- A terror attack leads to significant loss of life and commercial disruption.
- Russia-NATO conflict
- War in Ukraine protracted, leading to risk of escalation with NATO.
- Gulf tensions
- Regional conflict escalates, threatening energy infrastructure and increasing volatility.
Finally, analysts can miss. Markets can overprice and central bankers can not budge. So let’s keep this in mind as 2024 unfolds.
2024 brings potential changes in interest rates that has broad market implications and the housing market is expected to normalize after recent imbalances, with affordability being a key driver in housing market performance. And Groundfloor will keep making loans to responsible borrowers having well-conceived projects so that the platform can continue to deliver consistent risk-adjusted returns.