Friday, January 5, 2018

All Eyes on Interest Rates

Happy New Year!

Interest rates are the biggest single influence on the real estate market. There are many 'barometers' for the industry, but interest rates are the one that really can make a market move or stall. The feds have been using all of their influence to keep rates artificially low. The reason is that the real estate market was very fragile from 2009-2013. But as the market heated up the interest rates should have been allowed to creep up. The feds continued exercising their pressure to keep them down. I believe the economy was dependent on strong housing.

Buyer and sellers need to pay close attention to how increasing rates will effect them. Rising rates will make a house more expensive to buy.

For sellers that means a shrinking number of buyers that can afford the house. This will hurt the middle pricing the most. Wealthy people at the very top buying seven figure properties are less impacted. Although the max mortgage interest deduction for taxes was recently reduced so that may have a bigger impact than rates in the high end.

The bottom of the market will always have the most buyers. Even as rates rise the demand for entry level housing will remain stronger. People that once qualified for a 2000 foot 10 year old house may have to settle for a 1500 foot 20 year old house if rates are 2 points higher.

The middle takes the biggest hit in a rising rate market. 120% to 200% of median suffers when rates rise too fast for wages. Locally that means homes priced from $400k to $700k.

Buyers need to understand that waiting for a "better price" in a rising rate market is often counter productive. Most analysts are suggesting a slow rise, but a quick rise will lead to falling real estate prices. The higher rate is far more likely to kill a buyer than high price. I have written on this blog about the effects of high rates against high prices. Read here: Why Interest Rate is more Important than Purchase Price.

Cash buyers win big when rates move up but loan dependent buyers have to thread the needle of value trying to get a good price without paying the bank too much. Sellers have to consider the next home they will buy when selling the current house. Are they moving up to a larger house? Downsizing? Moving up could be a problem if rates are rising as the qualifying income needs to be higher to support higher rates the new house may soften in price but the higher rate could push the payment out of reach. Downsizing is less of an issue as the seller could come in  with a large down payment and a much lower principal balance.

Higher interest rates however are not all doom and gloom. Historically speaking the average rate on a mortgage over the last fifty years has been in the low to mid sixes! We have been in an extended period of sub 5%. So long has it been since rates were at 6 percent I would think millennial buyers can't remember ever seeing them that high.

When the stock market is roaring and mortgage rates are only at 4% investors that might otherwise buy mortgage backed securities may seek their fortune elsewhere. This makes underwriting tight as banks must lure investors to the mortgages through the prism of low risk. As rates flex up towards the 5-6% range the returns are better and investors get pretty excited. Guide lines can soften, making the mortgages a little easier to obtain for buyers. That helps keep the prices on existing homes moving up rather than flattening out. It's about keeping buyers in the market. This is only effective to a point. Back in the eighties when mortgage rates were in double figures the real estate market was brutal. Funny thing though, people still bought houses!

Rates ought to be around 5-6% right now, and the fed is moving away from its tinkering so we will starting creeping up towards that in 2018. We should see rates settle in at market values in that range over the next 12-18 months. Buyers shouldn't fret as that is a very "normal" range and still slightly lower than the historical average.

2018 should be a solid year for real estate. The out of control seller's market should soften into the near neutral market and that will be a welcome sight for me. I have never liked it when the market is too heavily tilted in one direction. Either a mild seller's market or a neutral market is typically best for all parties to a real estate transaction.

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