The Housing Market's Lock-In Effect and Its Implications for Real Estate and Mortgage-Backed Securities

The U.S. housing market is at a pivotal inflection point. For years, the "lock-in effect"—a phenomenon where homeowners with low pre-2022 mortgage rates avoid selling due to today's elevated borrowing costs—has constrained inventory and reshaped demand dynamics. Now, as mortgage rates project a modest decline in 2026 and demographic shifts gain momentum, investors are presented with a rare window to capitalize on structural realignments in real estate and mortgage-backed securities (MBS).

The Waning Lock-In Effect: A Catalyst for Market Rebalancing

The lock-in effect has been a dominant force since 2024, with 86% of homeowners in Q2 2024 holding mortgages below 6%. By early 2025, this share had dropped to 72%, as more homeowners were compelled to sell due to job relocations, household composition changes, or financial distress. However, the broader reluctance to sell persists, keeping existing home inventory at 4.6 months of supply in May 2025—still below the 5–6-month balanced range.

The Federal Reserve's anticipated rate cuts, projected to reduce 30-year fixed rates from 6.78% in July 2025 to 6% by 2026, will be critical. A 100-basis-point drop could unlock 5.5 million additional households into the market, including 1.6 million renters, according to the National Association of REALTORS®. This pent-up demand, combined with a 20% annual increase in existing home inventory, signals a transition from seller-dominated to buyer-balanced conditions in key markets.

Strategic Entry Points in New Construction

New construction is emerging as a linchpin for addressing the housing shortage. With existing home inventory constrained by the lock-in effect, newly built homes now account for 30% of total housing supply. Housing starts have rebounded to 1.3 million annually, and months of supply for new single-family homes reached 9.5 in October 2024—more than double the 4.2 months for existing homes.

Investors should focus on builders with strong balance sheets and regional expertise. For example, NVR, Inc. (NVR) and Toll Brothers (TOL) have demonstrated resilience by offering mortgage rate buydowns and design allowances, which mitigate affordability hurdles. Conversely, overleveraged builders like Lennar (LEN) and D.R. Horton (DHI), which have seen margin compression in overbuilt West Coast markets, pose higher risks.

A key trend is the rise of cost-efficient construction. Energy-efficient building codes, while adding $30,000 to new home prices, could be offset by policy shifts. If the Biden administration relaxes these mandates or if a Trump administration streamlines zoning approvals, construction costs may decline, boosting margins for builders.

Alternative Housing Solutions: Multifamily and Sustainable Developments

As affordability challenges persist, demand for alternative housing is surging. Multifamily housing is gaining traction in Sun Belt regions like Atlanta, Dallas, and Phoenix, where population growth and remote work trends are driving urbanization. Investors should consider REITs such as Prologis (PLD) and Equity Residential (EQR), which are expanding logistics and rental housing in high-growth corridors.

Sustainable housing is another high-potential segment. Net-zero buildings and ESG-compliant projects are attracting both private capital and government incentives. Developers leveraging green certifications (e.g., LEED, ENERGY STAR) can command premium pricing, particularly in high-income markets. For instance, Lennar's “GreenSmart” line of homes has seen a 15% price premium in California.

Mortgage-Backed Securities: Rebalancing Risk and Reward

The MBS market remains volatile due to the lock-in effect's impact on prepayment rates. With 76% of homeowners underwater on their mortgages, refinancing activity is minimal, reducing prepayment risk for MBS holders. However, as rates decline in 2026, prepayment speeds could accelerate, compressing yields.

Investors should consider sector rotation within MBS. Agency MBS, backed by Fannie Mae and Freddie Mac, offer stability but lower returns. Non-agency MBS, particularly those in Sun Belt regions with strong job growth, could provide higher yields as defaults remain low.

The Road Ahead: Timing and Diversification

The optimal entry point for new construction and alternative housing investments lies in the second half of 2025 and early 2026. By then, the Federal Reserve's rate cuts will have begun to ease borrowing costs, and regional inventory imbalances will create localized opportunities. For example, markets like Kansas City and Atlanta could see 20%+ home sales growth if rates hit 6%.

Diversification is key. A portfolio balancing new construction (25%), multifamily REITs (30%), sustainable housing (20%), and MBS (25%) can hedge against regional and sector-specific risks. Investors should also monitor geopolitical risks, such as potential Trump-era immigration policies, which could affect both labor supply and demand for housing.

Conclusion

The waning lock-in effect is not a sudden collapse but a gradual unlocking of pent-up demand. For investors, this transition offers a strategic window to position in sectors poised for growth. By prioritizing builders with resilient balance sheets, capitalizing on alternative housing trends, and rebalancing MBS portfolios, investors can navigate the housing market's next phase with both caution and confidence.