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