What Is Driving This Real Estate Economy?

We are asked on a regular basis to whip out our crystal ball and magic wand in regard to the real estate market. Everyone wants to know what the ongoing 2022 changes to the Federal Reserve’s interest rates are going to bring to home inventory, house prices, and mortgage interest rates, etc. Usually, my tongue-in-cheek answer is, “if we knew, we would likely be sitting on an island somewhere with a big cocktail and not selling houses.” In all seriousness, we look at historical data (all real estate is hyper-local!!!) and educate our clients with that data so they can make the the most informed decisions in this real estate economy.

We are not economists and recognize that most of our clients aren’t either. One of our colleagues, Rich Hopen, Esq., a Compass Agent in Short Hills NJ shares our data-driven strategic approach. He put together this easy-to-understand explanation of what is driving the economy and how it is affecting the overall real estate market in terms we can all understand and was kind enough to allow us to share it with our audience.

Read Past the Headlines!

Say goodbye to an overheated housing market, rising asset prices, stable pricing of consumer goods, a rising stock market, record low unemployment, and surging cryptocurrencies. We’re experiencing a tectonic shift in the economy. To better understand these changes and make sense of the headlines, here is a simple explanation of the market forces.

The Federal Reserve (The Fed)

The Fed is mandated to use monetary policy to achieve maximum employment and stable pricing. Their goal is to keep inflation at two percent.

Inflation is a measure of the decline of purchasing power and is tracked by the US Bureau of Labor Statistics. They calculate the Consumer Price Index (CPI) by measuring the average change in price, over time, of a “basket” of selected goods and services. The CPI is based on 94,000 price quotes from 23,000 retail and service establishments, and 43,000 rental housing units. The inflation report for May was higher than projected. It was 8.6%. That is alarmingly high and explains why you cringe when you pay for gas and groceries. The Fed can slow down inflation by making it unattractive for consumers and businesses to spend money. This is accomplished by raising the “Fed funds rate.”

The Fed Funds Rate

The Fed funds rate is the rate that retail and commercial banks charge each other for lending cash or excess reserves. It is also the rate that banks charge their customers for loans. When the Fed learned about May’s 8.6% inflation, it hinted that they would raise the current fund rate by 75 basis points (100 basis points equals 1% and 75 basis points is 0.75%). This was an increase from the anticipated 50 basis points. The Fed acted as expected on June 15th and raised the funds rate to 1.75%. This was the largest rate hike since 1994. When the Fed meets again in July, they will likely increase the rate another 75 basis points.

The Fed’s longer term projections were also revealed. The “terminal rate” is a mapping of projected rates over time on a “dot plot.” It shows that the Fed will raise rates to 3.4% by the end of 2022 and it will peak at 3.8% in 2023. Inflation is projected to drop from the current 8.6% to 5.2% by the end of 2022.


The risk of the Fed’s action is that they will slow the economy too much, and we will end up in a recession. According to the  National Bureau of Economic Research (NBER), recession is defined as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Is a recession inevitable?  Over 60% of CEOs expect a recession over the next 12 to 18 months according to the Conference Board.

Mortgage Rates

The Fed wants to see a cooling of the housing market and they have a powerful tool to do it. In addition to increasing or decreasing the Fed’s fund rate, the Fed can either sell assets from its $9 trillion balance sheet or buy assets. After the COVID-19 pandemic, the Fed purchased over $4 trillion of US Treasuries and mortgage-backed securities (MBS).

US Treasuries are treasury bonds (mature in 20 or 30 years), treasury notes (mature in two and ten years), and treasury bills (mature in four weeks to one year).

Mortgage-backed securities (MBS) are mortgage loans that are bundled and sold in the bond market.

Between April 2020 and April 2022, the Fed’s holding of MBS doubled from $1.35 trillion to $2.7 trillion. This represented an increase from 15% to 32% of the entire MBS market. When the Fed sells its MBS, it pulls money from the economy. This is also likely to increase the costs of loan originations. As mortgage rates climb, demand falls. After Memorial Day weekend, demand for mortgages hit a 22 year low.  The National Association of REALTORS (NAR) reported that home sales have fallen for six straight months.


Homebuilders are being hit from the demand and supply side. Therefore, they are seeing a plummeting demand for new homes while supply costs are rising. Residential construction material is up 19% year-over-year. A slowdown in homebuilding is going to cause a housing shortage after inflation is under control. After the last financial crisis, home building dropped below historic norms for more than a decade. This resulted in the housing shortage that we have been experiencing. If new housing starts continue to fall, there will not be sufficient inventory for the tens of millions of millennials looking to buy a house over the next decade.

Reprinted with permission of the Author and our Colleague, Richard M Hopen, Esq, Rich is a Licensed Broker Associate with Compass RE in the Short Hills, NJ office.

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