Will increase in interest rates cause property values to drop?

Question of the week:  Will increase in interest rates cause property values to drop?

Answer:  This is a good question, in large part because property values began to increase starting in early 2019 when interest rates began to drop, and then began to jump after the initial spike in rates the third week in March 2020 when lockdowns were put in place at the beginning of the pandemic; in less than two months from late March to early July the conforming rate dropped 1.25% (from 3.875% to 2.625%).

If dropping rates cause property values to increase, shouldn’t rising rates cause property values to drop?

Yes, no, maybe.

There are many factors that influence the price of a good or service. The primary factor is supply and demand. The higher the demand the higher the price, the lower the demand the lower price, the higher the supply the lower the price, the lower the supply the higher the price.

The surge in real estate prices during the pandemic was the result of higher demand and lower supply.

The initial increase in demand was due to the drop in interest rates, increasing purchasing power for those in the market. Using 35% of gross income for a mortgage payment, a couple making $90,000 would have a mortgage payment of $2625 per month.

In March 2019 when the high-balance rate was 4.375%, this payment would support a $525,000 30-year mortgage.

In July 2010, when the rate for a high-balance mortgage was 3.00% a $2625 month payment would support a $623,000 30-year mortgage.

In fifteen months, without any change in their income, this couple saw their purchasing power increase $100,000, a 20% increase

What this also meant was that couples making $50,000 saw their purchasing power increase from about $300,000 to $365,000, an increase of 22%.

From entry level home markets to upper, upper, home markets the lower interest rates enabled homebuyers to buy more house for the same monthly payment.

The pandemic caused a unique factor in demand as suddenly families who were comfortable living in their homes with parent(s) going off to work and children off to school most of the time and generally sharing the home in the evenings and weekends, found their homes had become offices, call centers and classrooms. Every room had one or more family members trying to work or study.

Families that pre-pandemic planned on staying in their homes until their children at least graduated high school suddenly needed more room. And thanks to low interest rates they could afford a bigger home with more room for everyone.

Families in apartments who previously could not afford homes in their areas suddenly could thanks to lower interest rates and were willing to buy the homes from the families who needed more room, because they too needed more room.

Vertical demand increased due to needs for more space and the ability to afford it.

A double-vortex of cheap money and need for more space pushed many families into the housing market who otherwise would not have been. This quick increase in demand overwhelmed the supply and prices started to increase as sellers had multiple offers on their properties.

The pandemic also put unique pressure on supply. Many families that thought about selling their homes, especially as prices were rising, were reticent because they did not want strangers going through their homes possibly leaving behind Covid-19 particles that could infect them. Remember in the early days, weeks, months of the pandemic? Could you become infected from surfaces, could someone with the virus infect a room and for how long? Will there be a vaccine in months, or years?

As the pandemic wore on and initial concerns (I almost typed hysteria), calmed, potential sellers then faced the dilemma of selling their home and then not being able to purchase a new one to move into. In March our question of the week was for people trying to sell a home to buy but couldn’t get offers accepted due to demand.

Sellers controlled the market and buyers were in a frenzy. Sellers were not seeing “multiple offers” in the traditional sense of three or four offers defining a hot property. They were receiving up to twenty, or more, for pedestrian listings and condition.

Over the past several months the markets have cooled somewhat. Despite rates being flat from July into September, the market has begun to level out as demand has cooled and supply has remained somewhat constant.

Back to our question, will rising rates cause demand to drop significantly or supply to increase thereby resulting in falling home values.

We now get to another aspect of supply and demand in real estate. The three golden words, location, location and location. In some areas of the state, and nation, supply is influenced by the ability of builders to add more inventory to the market in the form of new homes that compete for buyers with existing homes being put up for sale.

In areas where supply can be added to the market, home values are more susceptible to economic factors that can impact demand, such as higher interest rates.

In areas, such as most of the LA/Orange County region, where there is little to no vacant land to build large tracts of new homes, the amount of supply is limited to existing homes. This reduces the impact that economic factors can have on demand, such as higher interest rates.

In areas where supply is elastic there is a greater probability that home values may be negatively impacted by higher rates than in areas where there is low elasticity due to lack of space to increase housing supply.

The real underlying question to the impact higher rates will have on prices is, “will we see a drop in housing prices akin to a price bubble bursting?” Essentially, will higher rates pop the bubble.

Popping a price bubble, in my view, results in not just a cessation of price increases, but a reversal and prices declining. If this is the real question as to what may occur when rates begin to rise, my answer is in our region, no.

What I see as the impact on values from increasing rates is a return to a more balanced market in a region with limited supply of single family housing. While supply may remain relatively low, demand should be at a level that flattens the price curve to flat or slightly positive (think 1-3%) for the next cycle.

In real estate price bubble pop by a combination of over-supply and very small demand. The over-supply is typically created by families in economic trouble, primarily due to job loss, and selling their homes to eliminate their mortgage debt. Also adding to supply in these markets are foreclosed on properties being put on the market by lenders.

The current state of homeownership in our country is one of tremendous stability due to low fixed rate mortgages, families with mortgages they qualified for when funded, and most importantly significant equity. The final factor is what cushions any potential foreclosures as troubled homeowners have the equity to sell their homes, pay their mortgages and expenses of sale and likely have some equity left over.

As there always is when a market transitions from a sellers’ market to a flat or buyers’ market, there will be a period where sellers’ trying to capitalize on the spike in values are a bit late to market and price their homes based on the prior several months of climbing prices. These sellers, and their agents who put the properties on the market, choose to ignore the data showing more listings on the market and properties on the market for a longer period of time. In many cases these sellers are willing to sell, “only if I get my price,” which they want to be the highest in the market.

Yes, with higher rates the same income will transfer to a lower mortgage amount for qualifying, or a higher payment for the same mortgage, than current rates. Yes, this will result in some buyers foregoing moving up to their next home, or entering the market. However, families grow, families desire to own their own homes, people want to own their own homes.

Higher rates will dampen the frenzy we have experienced the past eighteen or so months, however they will not pop the bubble and result in a significant drop in prices. Some areas may see a drop of up to 5% in the short term, other areas may see their home values flatten out, and others see very small but steady increase in prices. Which of these results will occur will most likely be based as much, or more on location, location, location than increasing rates.

Let’s check back in a year and see what happened.

Have a question? Ask me!

Having said that rates will not have a big impact on home values, I will say that employment can be a much larger factor. Fewer workers in jobs that support homeownership means fewer prospective homebuyers as there is less income.

Today data was released showing personal incomes rose 0.2% in August, a modest increase due to reduction in government checks going out for pandemic relief. The increase in income was more than wiped out however by prices increasing 0.4% for the month, and 4.3% year over year. Inflation in consumer goods resulted in consumer spending showing a 0.8% increase from July. Normally increased consumer spending is good news for economic growth, less so however when a good portion of the increased spending is not resulting in more goods and services due to higher prices account for much of the increase.

Rates for Friday October 1, 2021: A lot of forces on rate markets with inflation, government debt ceilings and borrowing that has caused day-to-day turbulence. Week over week however, rates are flat from last Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Up Flat

30 year high-balance conforming                   3.00%  Up Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Once again, this week we are presented kabuki theater courtesy of our elected officials in Washington. In what has become an almost annual event the two parties square off in bluster, rhetoric, posturing and foot stomping threatening the end of democracy and our nation is near if the other party does not support their sides position in regards to raising the debt limit and passing spending resolutions. In the end the bills are passed and signed by the President at the last minute with each side scurrying to the cameras and microphones to encourage their base supporters to continue to provide them votes and cash so they can do it again. And again. And again.

The beauty of our political system is it results in the government we deserve. We have raised our daughters with the knowledge of consequences for their actions. They learn from these consequences, hopefully, and modify their behavior.

The American voter does not seem to understand the relationship between their votes, and support, of essentially the same people election after election, as they seem to expect better results, i.e. consequences, after each ballot they cast. The candidates no longer matter it seems, only the (D) or the (R) seem to matter. Hence…kabuki theater.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog