The California Buyer Purchasing Power Index (BPPI) figure remains negative, at -9.7 in the fourth quarter (Q4) of 2023. This figure tells you a homebuyer with the same income is able to borrow 9.7% less purchase-assist mortgage money than a year earlier when mortgage interest rates were well into their rise from historic lows.
While Q4 2023’s BPPI figure remains negative, the BPPI continues a consistent march upward from the basement levels reached at the end of 2022. Previously, the BPPI was positive during 2019-2021 due to lower mortgage interest rates.
Now in 2024, the negative BPPI is gradually rising to zero. Zero-level or better BPPI figures reflect the “normalizing” of mortgage rates at levels equal or lower than in 2023 for homebuyers and sellers — more money.
Looking back, mortgage rates were at their historic low in Q2 2021. Then, the 30-year FRM rate was at a low 2.7%. In this shifting financial environment, consider a household which in 2021 qualified to borrow $364,000 to fund the purchase of a home. Today, with the 30-year FRM rate averaging 6.8%, this same household qualifies to borrow just $239,000. That’s 34% less money to fund the purchase of the same home.
Analytically and critically, a homebuyer’s borrowing capacity sets what they can pay for a home with a zero to 15% down payment. To purchase that 2021 home in 2024, something has to give — but what?
Mathematically, home prices received by sellers must absorb the change in borrowed funds available to buyers — based on FRM rates and 31% of a buyer’s gross income for payments.
When FRM rates drop, seller pricing moves up rapidly, taking around 12 months to fully absorb the additional mortgage funding. It is not without irony that when FRM rates increase, seller pricing moves down slowly, taking 24-to-36 months to absorb the reduced funding available to buyers, called the sticky price syndrome.
The impact to homebuyer mortgage funding since 2021 has been devastating. The inevitable shockwave to hit seller home prices arrived quickly by mid-2022, causing prices to rapidly implode — interrupted in 2023 by a boost from the annual uptick during the spring buying season.
More acutely, the abrupt spike in home prices in 2021 was certain to be followed by an inevitable equal drop in prices as the pandemic stimulus of abnormally low mortgage rates was eliminated and normal bond market mortgage rate conditions returned.
Chart update 01/08/24
| Q4 2023 | Q3 2023 | Q4 2022 | |
| Buyer Purchasing Power Index (BPPI) | -9.7 | -10.7 | -27.5 |
The BPPI foreshadows home price movement
As the BPPI declines, so goes support for home prices (as sellers now realize).
In this decade’s rising mortgage rate environment, it is the seller whose participation in the home sales market is adversely affected — their equity melts away. From month to month, year after year, the scenario plays out as:
- buyers make the same maxed-out monthly mortgage payment for shelter at 31% of their gross income;
- mortgage lenders pick up increased portfolio yields, capturing additional interest earnings which reduce the funds available to borrower and buy a home;
sellers reduce their price by an amount equal to the present value (PV) equivalent of the lender’s additional interest earnings.
The gross income of a buyer and the mortgage rate in the bond market set the stage, not the seller’s list price. For example, homebuyers qualify for a maximum mortgage amount based on:
- their incomes and savings; and
- shifting interest rates.
Thus, any rise in mortgage rates instantly cuts the amount of capital funding homebuyers can borrow. In turn, the price they are able to pay for a home is reduced. Sellers are slowly discovering, as are sellers’ agents, that the math of increased interest rates for borrowed capital leaves all property worth less in price.
At the outset of the pandemic in 2020, mortgage rates descended to historic lows due to Fed efforts to stimulate spending by:
- inducing home refinancing for owners to pull cash — the ATM effect; and
- funding purchase-assist mortgages to support real estate prices and sales volume.
Then, in 2022, the Fed stopped its pandemic mortgage market activities. Mortgage rates, a product of the bond market, rapidly increased to ripple through buyers and make their mark on home sales volume — when sellers failed to quickly make price adjustments. The result was a freezing over of the market momentum built up during the Pandemic Economy.
Here in California, home prices began to decline on a monthly basis in mid-2022. As of October 2023, average California home prices are down — off 2% for low-tier and off 6% for high-tier — from their May 2022 peak. Absent 2023’s modest spring price bounce, this home price decline will resume and inventory for sale will increase heading into 2024.
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The Fed and the bond market influence mortgage rates
To end its pandemic period monetary policy of funding and setting interest rates on home mortgages, the Federal Reserve (the Fed) exited the mortgage-backed bond (MBB) market at the end of 2021.
On exiting, the funding and setting of fixed rate mortgage (FRM) rates returned to the bond market. This resulted in a jump in mortgage rates to match bond market MBB yields which, unlike Fed funding, are based on the 10-year Treasury Note rate plus a risk premium rate presently set at double historic norms in anticipation of a recessionary rise in mortgage defaults.
The result of all the pandemic fiscal and monetary stimulus of 2020-2021 caused consumer inflation to vastly exceed the Fed’s target of 2%. To rein in and tamp down excess consumer inflation, the Fed bumped up their benchmark rate several times in 2022 and 2023. This Fed activity directly increased interest rates on adjustable rate mortgages (ARMs).
Further, interest rates on long-term debt obligations, such as the 30-year FRM used to calculate the BPPI, reflect bond market investor perceptions about the level of success the Fed will achieve in their fight to lower consumer inflation and that fight’s effect on investment opportunities in the near future. When the Fed succeeds in its fight to normalize consumer inflation — as was finally materializing at the end of 2023 — bond market investors drop inflation expectations and accept lower yields, and FRM rates taper in tandem.
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While mortgage rates skyrocketed in the first three quarters of 2022, they were slashing buyer purchasing power. This brought on a cascade of altered buyer behavior — fueled primarily by seller resistance to pricing adjustments — resulting in a low level of need for real estate services. This attitude will worsen until agents discover that an endless variety of reports with disclosures about all aspects of a property’s condition will actually attract buyers in a recession.
The long-term outlook for the BPPI is a decades’ long period of remaining below zero, as mortgage rates resume their rise with the economic recovery, likely to gain strength around 2026. Until then, sellers and their agents can expect continued downward pressure on home prices.
The housing market will see declining sales volume and prices in 2024, with prices likely bottoming in 2026. Watch for a return of real estate speculators by 2025 to stop the price decline and provide a “dead cat” bounce during the slump, with a sustainable recovery taking off when end-user homebuyers return around 2026-2027.
Planning for the next few years in real estate transactions will require patience and a very different approach from the decades of recovery and property pricing since 1983 driven primarily by rate decreases.
About the BPPI
The Buyer Purchasing Power Index (BPPI) is calculated using the average 30-year fixed rate mortgage (FRM) rate from Freddie Mac (Western region) and the median income in California.
A positive index number means buyers can borrow more money this year than one year earlier.
A negative index figure translates to a reduced amount of mortgage funds available.
An index of zero means there was no year-over-year change in the amount a buyer can borrow with the same income. At a BPPI of zero, homebuyers cannot purchase at higher prices than one year before unless they resort to ARMs to extend their borrowing reach or greater down payment amounts.
As the long-term BPPI trend declines, the capacity of buyers to borrow purchase-assist funds is reduced. In turn, buyers needing purchase-assist financing can, on average, only pay a lesser price for a home.
To keep the inventory of homes-for-sale moving at a optimal turnover pace as MLS inventories build up, sellers on the advise of their agents will need to lower prices to accommodate buyer purchasing power or pull their properties off the market.
Proactive listing agents may need to fire sellers who harbor deal-killing illusions of past pricing.
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firsttuesday journal is a real estate news source. It provides analyses and forecasts for the California real estate market, and has done so since 1978.
