Will Rising Inflation Cool Down—or Further Inflame—the Hot Housing Market?

Realtor.com

Home prices aren’t the only cost that has been soaring over the past few months. It seems like just about everything, from rental cars to puppies, has gotten more expensive—and that could help determine whether home prices have more room to rise.

Inflation of goods and services rose 5% in May compared with the previous year, according to the Consumer Price Index. That means many household items and services now cost about 5% more than they did just 12 months ago. In other words, workers would need to earn 5% more than they did a year ago to keep up. This comes after years of inflation hovering around 2%.

Rising inflation could also affect the hot housing market. So will it be the force that cools down the double-digit price growth—or what catapults the cost of buying a home even higher into the stratosphere?

“We don’t know if these are temporary adjustment pains as the economy opens back up or if this signals a more consistent price increase that could be a problem,” says Realtor.com Chief Economist Danielle Hale. “We have seen much higher inflation, so the economy can handle this. [But] paychecks don’t stretch as far if the price of everything is getting more expensive.”

In the short term, rising inflation could further inflame the housing market, leading to an increase in demand as investors turn to real estate. Many believe homes are a safe investment that will grow in value, at a higher rate than that of inflation.

“Real estate is often looked at as a way to protect, if not benefit, from inflation,” says Greg McBride, the chief financial analyst at Bankrate.com. “In times of inflation, money often flows toward hard assets, things in which there is some scarcity. Real estate is one of them. They’re not making any more dirt. There’s a finite amount of land and homes available for sale at one time.”

Inflation also typically leads to higher mortgage rates. So the prospect of rates rising could drive more people into the market who want to take advantage of today’s record-low rates. And more buyers are likely to equal even higher prices.

“That’s an extra spur to stretch a little bit now,” says Lawrence J. White, an economics professor at New York University.

Many buyers want to get in before prices go up even further, says White. “It all feeds into this mentality that ‘I have to do it now,’ which feeds into higher prices.”

On the flip side, if inflation isn’t just a blip on the way toward economic recovery and sticks around for a while, it could cool down the hot housing market. Buyers will have less money to spend on housing if they’re paying more for everything else.

Inflation could also lead to rising mortgage interest rates, which tend to follow the U.S. Treasury and mortgage bond market. Bonds are generally considered safer investments that offer lower returns than the stock market. If inflation remains high, bonds become less profitable investments as the returns on them may be lower than inflation. And when bonds become less desirable, mortgage rates go up.

“As interest rates rise in the second half of the year, we will see some home buyers priced out of the market,” says Robert Dietz, chief economist of the National Association of Home Builders, a trade group.

Higher mortgage rates would likely lead to a softening in the housing market. Even incremental increases in mortgage rates add up to higher monthly mortgage payments. If buyers can’t afford the combination of higher prices and rates, that would lead to less demand for housing. However, prices in most markets aren’t expected to fall.

“It could cool the market if inflation moved up so much that it pushed mortgage rates significantly higher or threatened the health of the economic recovery,” says Bankrate.com’s McBride.

But for this to happen, he believes inflation would need to be more than 4% for a long period of time, at least a year or more.

Some degree of inflation is to be expected. It typically goes up as the economy fights it way out of a recession. That’s what’s happening now, as more people who lost their jobs during the COVID-19 pandemic go back to work and spend money on things like eating out, vacations, clothes, and other retail goods.

“Then the dust settles,” says McBride. “The concern is if inflation increases at a faster pace than we’re accustomed to and does so on a sustained basis.”

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