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Interest Rates and Housing Starts: An Unlikely Couple Climb Together

November 28, 2016

Mortgage rates are at a 17-month high.

But given positive housing activity, we see little reason to fret quite yet over rising mortgage rates. Housing activity remains brisk.

Indeed, construction of new homes surged nearly 26% to the highest level in nine years in October.

Housing starts posted at 1.32 million at an annualized rate, up from a revised 1.05 million in September. Multi-family starts lead the charge, but single-family starts kept pace, reaching a rate of 869,000 units, another nine-year high.

Better yet, permits are running 5% above year-ago levels. This suggests that home builders will continue to ramp-up construction to meet a steady increase in new-home demand. At the rate monthly starts are increasing, we’ll soon reach the historical long-run average of 1.5 million annual new starts. 

Most market watchers expected rising interest rates to restrain new-home activity. The expectation was reflected in home-builder stocks. As interest rates rose through October, home-builder stocks fell. The SPDR S&P Home Builders ETF (XHB), a fund of home-builder stocks, lost 10% of its value from late September through early November. The correlation appears obvious: rates rise, housing activity falls. 

But the causation is somewhat less obvious, and so, too, is the correlation. When interest rates (and mortgage rates) spiked after the November election, so did home-builder stocks. The SPDR S&P Home builders ETF is up 11% in the past two weeks. Investors have regained their confidence in the outlook for new housing.

As for the existing-home market, the news also remains positive.  Sales increased 2% to 5.6 million on an annualized rate to exceed most economists’ expectations. Year over year, sales are up 5.9% and are at their highest level February 2007.

How the housing data shape up for November will be of particular interest, given that mortgage rates are up a half-percentage point for the month. So far, the anecdotal evidence is encouraging. We’re seeing sales, and we’re seeing people still willing to finance their sales. 

We’re not really surprised that interest rates and housing activity have risen hand in hand. We mentioned last week that rising interest rates frequently correlate with gross domestic product (GDP) growth, which correlates with employment opportunities and personal wealth. As for personal wealth, stocks have traded higher this month: The Dow Jones Industrial Average is at an all-time high. The wealthier people feel, the more likely they are to engage a big-ticket purchase like a home. 

Yes, interest rates are an influencing factor on housing, but they’re not the only influencing factor.  Contrary to popular perception, it’s not all that unusual to see housing activity rise with interest rates. This occurred in the previous decade; don’t be surprised if the same dynamic plays out this decade. 

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