Rising Rates, Shifting Liquidity: Navigating Housing's New Reality

The Federal Reserve's June 2025 decision to hold interest rates steady at 4.25%-4.5% has sent ripples through the housing market, reshaping liquidity dynamics and creating uneven opportunities for investors. With mortgage rates hovering near 6.8%, the interplay between Fed policy, mortgage-backed securities (MBS), and regional housing fundamentals is critical to understanding where value persists—and where risks lurk.

The Fed's MBS Policy: A Double-Edged Sword

The Fed's balance sheet reduction—trimming $176 billion in assets since early 2025—continues to pressure mortgage rates. By maintaining a $35 billion monthly cap on MBS redemptions, the Fed has allowed MBS yields to climb above 5.5%, surpassing the 10-year Treasury's 3.8% yield. This spread creates an attractive risk/reward for income-focused investors, but it also tightens credit conditions for homebuyers.

Key Takeaway: Investors can capitalize on MBS through ETFs like iShares Mortgage Real Estate Bond ETF (REM), which tracks a basket of agency MBS. However, prolonged Fed hesitancy risks further widening spreads if inflation surprises to the upside.

Liquidity Shifts: A Buyers' Market Emerges

Rising inventory and prolonged days on market (DOM) signal a historic shift toward buyer-friendly conditions. National active listings hit 1.036 million in May 2025—up 27.5% year-over-year—while DOM rose to 53 days in June, a 4% annual increase. This inventory expansion has softened prices in overheated Sun Belt markets like Austin and Tampa, where speculative construction and affordability strains are testing resilience.

Regional Divide:
- Sun Belt/Mountain West: Overbuilt markets (e.g., Punta Gorda, Florida) face price declines as inventory surges.
- Midwest/Northeast: Tighter supply (still 12% below pre-pandemic levels) supports pricing power.

Undervalued Sectors: Where to Find Value

1. Midwest and Sun Belt Affordable Markets
   Cities like Youngstown, Ohio ($185k median), and Rockford, Illinois ($249k), offer strong affordability and job markets (e.g., 3.1% unemployment in Appleton, Wisconsin). These areas are underpenetrated by institutional investors and boast stable local economies.

2. Multifamily Properties
   Despite a 4% dip in starts, multifamily demand remains robust as renters outpace homeownership growth. REITs like Equity Residential (EQR) and Mid-America Apartment Communities (MAA) offer 4-5% dividends and exposure to rising rents.

3. MBS-Backed Income Plays
   MBS yields above 5.5% provide a hedge against stagnant Treasuries. Consider PIMCO Mortgage Opportunities Fund (PMO) for diversified MBS exposure.

Risks to Monitor

• Policy Uncertainty: A potential Trump administration's immigration policies could exacerbate labor shortages, slowing construction and worsening housing shortages.
• Rate Volatility: If the Fed delays cuts beyond 2026, affordability could further erode, prolonging DOM and price declines.

Investment Strategy: Balance Risk and Reward

• Short-Term: Focus on Midwest/Sun Belt undervalued homes with price-to-rent ratios <15. Use rate buydowns offered by 60% of builders to secure deals.
• Long-Term: Allocate 10-15% of a portfolio to MBS ETFs and multifamily REITs for steady income. Monitor the Fed's inflation outlook for rate-cut timing.
• Avoid: Overbuilt Sun Belt markets and high-end coastal homes, which face prolonged softness.

Conclusion: Patience Pays in a Split Market

The Fed's cautious stance has created a two-tiered housing market: opportunities in overlooked regions and income streams via MBS, versus risks in overbuilt areas. Investors who prioritize valuation metrics—like price-to-rent ratios—and stay nimble as rates evolve will position themselves to thrive in this uneven recovery.

Final Tip: Act swiftly in Midwest markets before inventory tightens further. In the South, wait for DOM to stabilize above 60 days before diving in.