ISA Briefing: The impact of residential mortgage resets
In recent editions of LaSalle Macro Quarterly (LMQ), many charts have highlighted interest rate rises. LaSalle has especially focused on the repricing of income-producing real estate that rate rises have triggered in much of the globe. But the spike in rates is also having an impact on owner-occupied residential real estate, which accounts for a much larger share of the global property pie than do institutional assets. As we release the LMQ for Q3 2023, we look at the broad implications of higher residential mortgage rates, and how they vary by country. Even if institutional investors do not directly touch owner-occupied housing, they should consider the risks (and a few opportunities) caused by these dynamics. Higher residential mortgage rates have implications for both new buyers and existing owners. For new buyers, higher rates reduce the purchase price they can pay (assuming a fixed amount of debt service). In practice, buyers cope with this by dedicating a larger share of their income to housing, or by scaling back or postponing their home purchase ambitions. For economies in which housing constitutes a meaningful share of the economy, this can create a noticeable drag on GDP growth. It may also put downward pressure on home prices, which can have indirect wealth effects on consumer spending. (So far, house prices for key countries have held up reasonably well during this period of rising rates—as shown in the chart on page 7 of the LMQ—but risks remain.) For existing owners, much depends on the specific terms of the mortgage. The US mortgage market is unique globally in having a very large share of loans with rates that are fixed over a fully amortizing term (typically 30 years), according to data from Fitch. Assuming they do not move, borrowers can continue to enjoy low fixed payments. Elsewhere in the world, residential mortgage rates are usually floating or fixed only for a limited time. When rates rise, they filter through to borrowers gradually as fixed rate periods end—in other words, when rates reset. Depending on the mechanism for rate resets, they can cause a direct hit to disposable incomes. Households may react to this by scaling back spending elsewhere, or in the extreme, leaving the ranks of homeownership. These impacts will be more significant in places where consumers already have a high debt service burden. For investors in income-producing institutional real estate, there are two aspects of these dynamics that are especially relevant. One is the broad recession risk that comes from weaker housing markets and stretched consumers. Oxford Economics has cited differential exposures to mortgage resets as a driver of divergence in near-term economic growth between the US and Canada. Second, the substitution effect from owned to rented housing may provide a boost to both multifamily and single-family rental demand, potentially driving stronger performance for residential strategies. Contributors: Brian Klinksiek Global Head of Research and Strategy Chris Langstaff Canada Head of Research and Strategy