Interest rates and affordability cause cooling
effect on Minnesota’s housing market

New home under construction
Closed home sales in June declined by nearly 14% year-over-year across Minnesota.

As the Federal Reserve continues to raise interest rates in an attempt to bring down 40-year-high inflation, it has had a clear impact on the local housing market. Minnesota was facing a housing inventory and affordability crisis prior to the Fed raising rates, which was pricing many families out of homeownership. With the Fed’s efforts to increase the federal funds rate, higher mortgage rates have been the last straw for many families looking to purchase a home.

Closed sales of homes in June declined by nearly 14% compared to a year ago, with a total of 9,208 properties sold across the state, according to the Minnesota Realtors®. New listings of homes for sale were also down 6.4% year-over-year. With homes sitting on the market a little longer the total number of homes for sale increased, up 21.4% over last June.

The market now has a 1.7 months’ supply of homes for sale, which is still far below a balanced market of five months’ supply of homes for sale. Even with more homes on the market, prices continue to climb as the market remains competitive.

“As we look at the decline in closed sales, it’s important to remember that these numbers are relative to last June’s abnormally heated market. What we are seeing this month is more closely aligned with historical norms for this time of year,” said Chris Galler, CEO of the Minnesota Realtors. “Still, as higher interest rates and inflation continued to play a role, many first-time buyers were sidelined. The buyers who are successfully competing have the money to stay in the game. This dynamic is unlikely to change until we can help more buyers close the gap with tools like down payment assistance, and broadly increase construction of more affordable homes.”

The new construction sector of the housing market is seeing a cooling effect from interest rates as well. According to the U.S. Census, the number of permits pulled for new single-family homes are down 19% from this time last year. In the Twin Cities, metro permits for new single-family homes are down 9% year-to-date, according to June data from the Keystone Report.

National housing sales have reverted to pre-pandemic 2019 levels, according Zonda’s latest National Housing Market Update. Ali Wolf, Zonda’s chief economist, says there is an argument to be made that many parts of the country have softened and weakened in response to the ongoing economic conditions.

“Housing slows quicker than the rest of the economy, because when the rest of the economy is good, interest rates go up and housing slows,” said Wolf. “And then housing can bring the economy down. But on the other side, housing rebounds quicker.”

According to Zonda’s most recent division president survey, collected during the third week of July, 30% of builders reported demand to be slower than expected, but not worrisome. Approximately 55% of respondents reported demand was both slower than expected and a cause for concern.

“You’ve reached a point where, as the monthly mortgage payment has gone up at least 40% since the beginning of the year, there are some people who have stepped back,” said Wolf.

There are signs that the pause in the housing market from interest rates is starting to rebound. Mortgage applications ticked up 1.2% at the end of July, according to the Mortgage Bankers Association (MBA). The slight increase came as mortgage rates dropped 0.31 percentage point from 5.74% to 5.43%.

“The drop-in rates led to increases in both refinance and purchase applications, but compared to a year ago, activity is still depressed,” said Joel Kan, MBA’s associate vice president of economic and industry forecasting. “Lower mortgage rates, combined with signs of more inventory coming to the market, could lead to a rebound in purchase activity.”

Kan is not the only one seeing signs of opportunity in the housing market for homebuyers. Economist Elliot Eisenberg believes mortgage rates will level out and provide opportunities for buyers.

“The market is improving for buyers. Inventory is starting to rise. It has been very low, for a very long time. In terms of housing units, physical units of available-for-sale inventory hit rock bottom just three or four months ago. Now, it’s finally really rising,” said Eisenberg. “This is the best time it’s been to buy a house in a very long time. It doesn’t mean it’s a great time to buy a house. There still is not as much inventory as there’s been in the past, and it’s still not back up to a normal level, but it’s better than it has been for two years.”

Eisenberg believes while homes sales will slow during a potential recession in 2023, the overall demographics stand. This means our housing market will remain undersupplied unless we continue to build more homes.

“The number of these younger millennials, the 29- to 33-year-old cohort, they’re the largest group in U.S. history — bigger than any baby boomer cohort. So, there’ll be a lot of home demand for these folks,” said Eisenberg.

The concern is growing that as new home production slows from the current economic conditions, the market will be even more undersupplied when it recovers. Housing First Minnesota, the state’s trade association for the housing industry, believes rising interest rates should put pressure on state lawmakers and regulators to take action to bring down the cost of building new homes in Minnesota.

“It’s more important than ever that we take a look at the regulatory challenges and outdated zoning restrictions that are driving up the cost of housing, so homebuilders can get back to producing more starter homes for Minnesota families,” said James Vagle, CEO of Housing First Minnesota