How Residential Land Development Is Winning Against High Interest Rates
By Steve Sheldon, PE
Principal, Land Development
Back in late 2022, the Federal Reserve started a series of interest rate adjustments to curb inflation, sending a panic into the development world. Interest rates that had been historically low would be raised to 5, 6, maybe even 7%. The prevailing thought was that the homebuying world, and thus the development world, would be decimated.
Looking at house sales numbers from October and November of 2022, those predictions appeared true and dire. Several development companies made moves to limit that damage. But beginning in December, those sales numbers returned to 2018 levels and have stayed there through today, defying the experts’ predictions.
How could this happen, given that interest rates are more than double what they were just 18 months ago?
Several factors have played into this, but here’s a significant one I thought was interesting. Because interest rates were historically so low in 2020 and 2021, many buyers took advantage of the low interest rates, and many existing homeowners refinanced their homes to lock in the 2% and 3% rates available.
Today these same homeowners feel “locked in” to their existing mortgages. And I don’t mean that in a negative way ... it just means that they can afford more house for the same amount of monthly payment, given their 2% or 3% mortgage.
And the difference is substantial. A $300,000 house, with 20% down, results in a monthly payment of $1,597 today with a 7% interest rate, but a monthly payment at 3% for that exact same loan is $1,012. So these “locked in” homeowners are not selling their houses, which puts a significant squeeze on the amount of existing inventory available for purchase.
At the same time, homebuilders have come up with some creative incentives for new homebuyers, including free refinancing with the purchase of a home at today’s interest rate, in addition to more standard incentives like cash back and upgrades.
The combination of lack of existing home supply and incentives for new home purchases is a major reason why home sales in 2023 have defied the experts’ projections, and why development continues seemingly unabated.