Housing Market Slowdown: Navigating Risks and Opportunities in a High-Rate Environment

The U.S. housing market in 2025 is a study in contradictions. While home prices remain at record highs, growth has slowed to a crawl. Inventory levels have ticked upward, yet they remain far below historical averages. And despite a surge in job creation, home sales remain below pre-pandemic levels. This deceleration, driven by elevated mortgage rates and weak buyer demand, has created a unique investment landscape. For real estate and mortgage-backed securities (MBS) investors, the challenge lies in balancing caution with opportunity.

The Housing Market's Stagnation: A Double-Edged Sword

The second quarter of 2025 revealed a housing market caught in a tug-of-war between affordability constraints and lingering supply shortages. Nationally, median home prices rose 1.7% year-over-year to $429,400, but this growth was uneven. The Northeast and Midwest outperformed, with the Northeast seeing a 6.1% increase, while the South and West lagged. Florida and Texas, in particular, faced price corrections as new construction offset demand.

Mortgage rates, which averaged 6.6%–6.9% in Q2, have become a critical bottleneck. High rates have created a “lock-in” effect, where homeowners with low pre-pandemic rates avoid selling, shrinking the inventory of available homes. This dynamic has left first-time buyers in a bind: their average monthly mortgage payments now consume 38.7% of income, a slight improvement from 2024 but still unaffordable for many.

For real estate investors, the implications are clear. While price growth in certain markets (e.g., Toledo, Ohio, and Jackson, Mississippi) suggests localized resilience, the broader trend points to a market in hibernation. New construction, particularly in the South and West, could eventually alleviate supply shortages, but timelines remain uncertain. Investors should prioritize markets with strong fundamentals—such as job growth and population inflows—while avoiding overleveraged properties in regions experiencing price corrections.

Mortgage-Backed Securities: A Tale of Two Risks

The same high-rate environment that stifles home sales has reshaped the MBS landscape. As of May 2025, the Bloomberg US MBS Index yielded 5.2%, a 68-basis-point spread over the 10-year Treasury—a premium that makes MBS more attractive than corporate bonds. This yield advantage is bolstered by low prepayment risk. With most existing mortgages locked in at 4% or below, refinancing activity remains minimal, reducing the likelihood of early principal repayments.

However, this stability comes with a caveat: extension risk. If rates stay elevated or rise further, homeowners may delay refinancing or selling, prolonging the time it takes for MBS investors to recoup their capital. This risk is particularly acute for non-agency MBS (NA RMBS), which lack government guarantees and face higher default probabilities in a downturn.

Agency MBS, backed by Ginnie Mae, Fannie Mae, or Freddie Mac, remain a safer bet. Their explicit or implicit government support ensures minimal credit risk, even as the housing market slows. For investors, this makes agency MBS an appealing fixed-income option, especially as the Federal Reserve signals potential rate cuts later in 2025. A steeper yield curve and wider spreads in NA RMBS also present opportunities for those willing to take on additional risk for higher returns.

Strategic Recommendations for Investors

1. Real Estate: Prioritize Defensive Plays
2. Residential REITs: Consider REITs with exposure to affordable housing or manufactured homes, which cater to first-time buyers and renters.
3. Multifamily Housing: With single-family sales stagnant, demand for apartments remains resilient, particularly in urban areas with strong job markets.

4. Avoid Overleveraged Developers: Homebuilders with high debt loads (e.g., Lennar, KB Home) face margin pressures in a high-rate environment.

5. MBS: Balance Yield and Risk

6. Agency MBS: Ideal for conservative investors seeking stable cash flows. The current yield premium over Treasuries offers a compelling risk-reward profile.
7. NA RMBS: For risk-tolerant investors, NA RMBS could provide higher returns if spreads narrow as rates decline. However, monitor credit quality closely.

8. Duration Management: Given extension risk, consider shorter-duration MBS to mitigate reinvestment uncertainty.

9. Policy Watch: Keep an Eye on Trump's Housing Agenda

10. Potential changes to zoning laws or immigration policies could impact construction timelines and affordability. Investors should factor in regulatory uncertainty when evaluating long-term exposure.

Conclusion: A Market in Transition

The U.S. housing market is in a holding pattern, with high rates and weak demand creating a stalemate between buyers and sellers. For real estate investors, patience and selectivity are key. Meanwhile, MBS offer a unique opportunity to capitalize on yield premiums and low prepayment risk, provided investors navigate extension and credit risks carefully. As the Federal Reserve contemplates rate cuts and policymakers debate housing reforms, the coming months will be critical in determining whether this slowdown is a temporary pause or the start of a deeper correction.