Housing Affordability Challenges of High Interest Rates
Three years after the onset of COVID-19, the pandemic’s effects on the U.S. housing market and housing affordability continue to unfold. The rise of remote work enabled many to move to more affordable areas, while low interest rates supercharged the housing market, sending housing prices soaring nationwide. Despite rising interest rates, homes have held onto most of their gains in value, shutting would-be homebuyers out of the market and, in turn, keeping rental demand high and rents elevated. On the heels of this emerging “new normal,” the National Housing Conference hosted its Solutions for Affordable Housing convening in December 2022 in Washington, D.C. The convening featured a panel discussion examining the role of high interest rates in shaping the landscape of the U.S. housing market and the consequences for housing affordability and municipal budgets and services. Participants included Mike Fratantoni, chief economist at the Mortgage Bankers Association; Skylar Olsen, chief economist at Zillow; Jason Fichtner, vice president and chief economist at the Bipartisan Policy Center; and Sam Khater, vice president and chief economist in the Economic and Housing Research Division at Freddie Mac.
The Cascading Unaffordability Problem
Low interest rates, the rise of remote work, and the persistent underproduction of new housing conspired during the pandemic to dramatically raise housing prices. Fichtner and Olsen described how remote work enabled workers in high-cost, high-productivity areas to move in droves to lower-cost cities such as Boise, Idaho, during the pandemic. This sudden disruption to local housing markets raised housing costs for existing residents, who, in turn, sought out lower-cost areas nearby, reproducing the dynamic in these areas and essentially spreading unaffordability. For some cities, the sudden departure of high-income households and the decline in downtown property values, precipitated by the rise in remote work, may make funding city services more challenging in the short to medium term. Khater called this phenomenon the cascading effect of unaffordability, spreading a problem once concentrated in high-performing metropolitan areas much more broadly.
Panelists agreed that the market’s current dynamics have baked in a regime of high housing costs that will be difficult to break. Khater identified housing’s core conundrum: the lack of supply has contributed to rising housing prices, which are a major factor in calculating inflation; high inflation, in turn, prompts the Federal Reserve to raise interest rates to cool the economy, with housing being among the sectors most immediately impacted by changing rates. The resulting decline in the housing market disincentivizes developers from building more housing, setting the stage for the next round of unaffordability after the overall economy has improved and interest rates again decline.
Durable Solutions to Housing Affordability
Olsen argued that, over the long run, implementing policies that target densification and increased supply is the only way to break the cycle of decreasing affordability and the resulting downstream challenges it poses for governments. Fratantoni reported that approximately 900,000 multifamily units are currently in the production pipeline — the highest number since the 1970s. Although these units are not evenly distributed, they are expected to exert downward pressure on rental costs.
Panelists also advocated for other solutions that promote housing equity. An expansion of the low-income housing tax credit program, for example, would increase the production of income-restricted units. To increase equity in homeownership, the panelists suggested that policymakers consider reforming the mortgage interest deduction, which generally benefits wealthier homeowners rather than renters but which has only a marginal positive impact on the decision to become a homeowner. Converting the interest deduction to a tax credit, Fichtner said, could provide would-be homebuyers with lower incomes relatively more help than the current system does.
Policies that encourage firms to construct more starter homes (homes up to 1,400 square feet) could also improve overall housing affordability. Khater characterized the lack of starter home supply, which historically provided younger households an affordable path to move from rental units to homeownership, as the single most challenging economic question facing the United States, given its numerous cascading implications for others seeking affordable housing.
Challenges Moving Forward
Some possible solutions, warned panelists, may have a limited or even counterproductive impact. The conversion of downtown office buildings — underutilized since the rise of remote work — into residential buildings faces substantial challenges. Fichtner, however, pointed out the importance of revitalizing underutilized urban downtowns to support area businesses and increase the city’s tax base, which helps fund needed services.
Olsen cautioned that generational change is a confounding factor in pursuing affordability solutions. For example, older people have been staying in their homes for longer periods, effectively hoarding housing. Consequently, certain policies aimed at increasing housing supply may have downsides. Olsen pointed to accessory dwelling unit (ADU) construction as one policy that increases the available housing supply and access to the suburbs for renter households but also can raise property values for owners and, thanks to the income that ADUs generate, may encourage older homeowners to retain properties that they might otherwise have sold.
Over the past several years, rapid changes in work patterns, living preferences, and interest rates have shaken housing markets in the United States. Although the panelists emphasized the scale of the affordability challenge and its likely persistence, they also underscored the need for broad, responsive policy solutions to prevent the calcification of widespread housing affordability and ongoing housing inequity.