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Will Real Estate take a whack as we move into higher interest rates?
- Higher interest rates will put pressure on Real Estate buyers by making mortgages more expensive.
- How much more expensive will a mortgage be?
- How did Real Estate prices fair with previous regimes of higher interest rates.
Home owners, buyers and Real Estate investors all have reason to be concerned about the recent interest rate hike by the Fed. We have now begun the transition to higher interest rates with the Fed’s move to raise the Fed Fund rate by ¼%. That’s not that much of a move, but it has doubled the previous rate and above all it means the process that will bring as back to higher interest rates has now begun.
Why would the Real Estate market take a hit?
The fear now is that higher interest rates will stifle the property market. Well that is indeed a risk, which also means it might not happen. It would certainly be the case if interest rates rise faster than the market can assimilate. If the Fed keeps raising interest rates and the economy cannot keep up at the same pace then we could see a large slowdown in the demand for houses from individuals and institutions.
This is easy to conceive as peoples salaries are not rising fast enough and not enough new jobs are being created then there will be less demand for residential property. People will also have less money as they will be paying higher interest on other items often bought with a loan like autos. From the point of view of commercial property if the public is not spending as much in stores and entertainment then this type of real estate also loses value.
Increases in interest rates also make mortgages more expensive. This means that a property becomes less affordable even though the price may remain the same. This will happen for residential and commercial property alike. Ultimately if interest rates rise faster than the economy, prices will probably begin to fall. If the market feels that interest rates are rising too quickly it would probably cause prices in those REITs you own to fall faster too.
Having said all that if the economy does well and expands at a sufficient rate it will be able to accommodate restrictive monetary policy, that is higher rates. In this scenario we should also see inflation begin to rise as the economy is heating up. Real estate is known for being positively linked to inflation, so prices could even get a boost in this case.
So how much does a mortgage change?
Those who have a fixed rate mortgage have nothing to worry about, of course. But for the many that have a variable rate mortgage higher interest rates are going to be of concern. There are many mortgage calculators on-line, I particularly like this one, mortgagecalculator, as it allows you to contemplate taxes in your monthly payment.
You can see that on a $250,000 mortgage a ¼% rise in the interest rate will only change your monthly payment by $33.14. But considering the loan still has 20 years to go, the overall change in cost during its lifetime is an increase of 3.18% or $7.952. A 1% rise means an extra cost of $32,385, or 12.95% of a $250,000 mortgage with 20 years to maturity.
How have Real Estate prices faired in the past?
The next couple of years won’t be the first period of rising interest rates. In the recent past we’ve seen this happen various times. During some of these periods property values continued to rise. For example, the two periods from 1993 to 1995 and 1998 to 2000, we saw interest rates increase. In both periods returns for real estate still remained positive.
The chart above shows how the NCEREIF (which is a nationwide property index) showed positive price increases for both periods. We can also see that in certain periods where interest rates were falling so where prices in the property index. The period that stands out the most goes from 1990 to 1993. As interest rates begin to decline so do property price increases decline. As the fall in rates continues property price changes even become negative.
We are not bound to see prices fall rapidly or even stall for sure. But what will be necessary for the property market to continue its buoyant price levels, is an economy strong enough to adjust to the higher interest rate regime.
If the economy is expanding rapidly it will be absolutely necessary to raise interest rates, and it will be easily absorbed. If the Fed decides however that the transition back to more typical interest rates is to be made despite an economy that is not expanding fast enough, then we might see prices falter.
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Any significant increase in interest rates will hammer real estate prices. The recent token increase is just testing the waters.
It's NOT whacking day yet...
We'll see how long the rate rise lasts.
Of course rising long-term interest rates will decimate the value of real estate. Just as falling long-term interest rates provided quite abnormal returns to real estate.
Over the long term, real estate 'appreciation' at the rate of inflation, assuming proper maintenance, is normal. We've obviously seen a multiple of that over the past 35 years of falling rates, so the rising rate environment is likely to user in dramatic underperformance of RE assets. Operating businesses will perform far better and will eventually be able to re-build their real estate portfolios as REITs and other leveraged speculators are forced to puke up properties in distress.
They took care of that. Foreign buyers will take up the slack due to huge tax break in spending bill ... http://www.zerohedge.com/news/2015-12-20/obama-abruptly-waives-1980-fore...
If there is no job growth and higher living costs how are buyers supposed to enter the market?- near zero interest mtg. has not juiced the market for the past few years so what is supposed to get them in the market now?
..supply needs to follow demand, not the other way around.
Houses are still pretty cheap in the boonies of Ohio, Indiana, Missouri, etc. Too bad no one wants to live there, esp the Chinese.
One of the unmentioned items is the renter sitting on the sidelines due to the rising cost of rent that makes a mortgage increase look like kids stuff. It is hard to have a conversation about rising interest rates affecting housing when one considers the number of buyers being priced out of the low to mid end of the market by rent costs as a percent of income.
If rent continues to achieve double digit year over year increases, it will matter naught what the interest rate is or would be as the pipeline will be severely pinched. Even quelling rent to current norms would not help much as wages would take years to catch up to the rental increases.
Renters who can absorb an annual or bi-annual $200/mo increases can absorb the nominal interest rate increases...if they ever break free from the rental market.
Rents have not been increasing double digits year over year, and negative rent growth in a higher rate environment is likely as it becomes very expensive to hoard real estate.
Thanks for the pointer - I should've put "...in many/most/all high growth areas" to contextualize the double digit rent growth. Obviously, St Louis MO is not Cupertino, CA and nationally rents are seeing 4-6% depending on what is being measured and for what period (e.g. 2 bed vs 1 bed, and quarterly vs monthly, etc.)
"fair"?
I think what is being missed here is perception. People will see interest rates rise just a little and the lemmings will jump in or be priced out forever. I was in that camp circa 2005 (followed by discovery of ZH in 2008 when I couldn't sell and was looking for answers). The remainder will wait to see what shakes out. Waiting will slowly but surely drop prices over time. Refi is going to shit the bed.
Just how high can prices go? Seems to me the more the sheep pay, the less there is for the rest of the economy. Unless we go down the path of 125% LTV loans again... which I'm sure we will. Forward credit!
It's important to remember that the driving factor for what's left of the middle class is payment. We saw it in the 70's, a period that the author chooses to ignore. Rates rise, prices drop to keep the payment "affordable". In the late 70''s when 30yr mortgages carried rates as high as 18%, middle class earners could still swing the payment because a 3 BR tract house in the suburbs could be had for ~$50k.
This 0.25% rate increase is not the first step to 10% mortgage rates. Look at the change in the mortgage payment annual constant change if rates move from 3.5% to 4.5%. Both are still very low and deals still work.
Yep. My dad says his first mortgage was 16.5% in the 1970s. He was later able to refinance down to 12%. He said in those days you HAD to put at least 20% down and prove you had a stable job and have a decent bank account as well as little debt. Mortgages were kept local most of the time so you character was somewhat a factor also. Banks did not expect to pass all their losses onto someone else (namely, the US taxpayer) so they were much more prudent.
The RE market is in for a whopping correction OR will stay out of reach for most Americans another decade.
I would love to live in that kind of world. Can we blame the Zios for the changes and the subsequent disaster/s?
>>> How did Real Estate prices fair with previous regimes of higher interest rates.
fair. verb: to make (typically wood) smooth and planar. Usage rare.
fare. verb: to proceed or to emerge. archaic verb: to feast or to quaff.
That shit drives me nuts. How can you expect to have your argument taken seriously when you can't express it writing correctly?
That's "rediculous"!
The author sidesteps the underlying issue - which isn't even the latest .25% hubub. It is: How much future demand has been pulled forward and expended as a result of the $cheap money policies of the past (how many years?), and how much more future (residential/commercial) real estate demand can yet be pulled foward before saturation ensues - or has it already...?
useless article based on the assumption the token rate increase had anything to do with an improving economy
If interest rates were to actually rise to "normal," market based, levels (3%, 5%, 7% ???) then yes, real estate would take a hit. Economics - supply and demand - works. People can only afford to buy so much. If the cost goes up (increase in monthly payments due to higher interest rates) demand will go down and supply will go up. Prices will then fall.
But, we all know that interest rates will NOT go to market based rates any time soon. They will head back to zero, possibly negative, in the near future.
I agree. There is no "market" in housing right now; only manipulation by the Fed/banks and lots of money flooding in from overseas, some legal and lots illegally 'earned' money. I read the Canadian gubmint finally researched their foreign-owned houses and compiled a list esp of all the Chinese Mainlanders who bought those multi-million homes in Vancouver. They cannot decide whether to tax these people or ask them for proof of origin of the purchase money.
Confiscation of these houses is in the wind as gubmints go broke and get desperate for everyone eleses' money and foreign-owned RE is an easy target.
will pee-wee herman "take a whack"?
http://www.bizjournals.com/houston/morning_call/2015/12/houston-apartmen...
Home inventory grows as sales slow in Houston, report findshttp://www.bizjournals.com/houston/news/2015/12/18/home-inventory-grows-...
The rate rise (mortgage rate increase, auto loan increase and credit card increase, etc) plus other factors such as massive layoffs of high paying people in the energy industry and soaring property taxes and home insurance costs will take its toll this coming year.
No. The increase in mortgage rates will not be noticable.
But the increase in taxes and the cost of living will. Coupled with a continued drop in demand do to borrower exhaustion, the middle class home buyer will slowly, then abrubptly realize that they have become slaves to the chosenites. It will be too late.
golden rule of real estate; buyers buy a payment and get the most expensive home they can afford....
so therefor home prices will take a breather.
former re broker.....