rising interest rates vs falling prices
i just sold a home, and have considered renting vs buying. i need to be in the renton/eastside area. i expect renton to be flat or slightly negative in the next 24 months. but i also think interest rates will go up again. has anyone ever analyzed the relationship between rising interest rates and home buying power? assuming a $300k house , if it drops to $270k but rates rise 3% would i have been better off buying at a higher price with a lower rate?
i actually remenber when home mortgage interest rates were over 11%
i actually remenber when home mortgage interest rates were over 11%
Comments
This is a hobby horse of mine.
If you start with the assumption that people buy houses on the monthly payment, rather than on the total price (99% of home buyers), then the monthly payment is what the house is worth. You only use the purchase price as a current benchmark to conveniently gauge what your monthly payment will be.
The highest monthly payment, or A, is what the house is worth. If the market conditions require a teaser intro interest rate, then the price of the house goes down precipitously as that rate adjusts. Going from 4% to 8% really hurts.
As interest rates fall, the same monthly payment buys more house. The inverse is also true. As kinky financing presented itself, houses bacame much more expensive. As kinky financing gets crushed, so will home values
This is derived from the amortization formula, which is:
A=P[(i*(1+i)^n)/((1+i)^n-1)]
Where:
A=monthly payment
P=Total purchase price
i=monthly interest rate (if you had a 6% loan, the monthly i is .005)
n=number of payments (359 for a 30y, or 179 for a 15y)
You can see that i and P have an inverse relationship, and it is exponential.
You can also do this in MSExcel:
=pmt(i,n,-P)
i, n, & P are as defined above.
You can easily set up a spreadsheet to show how this relationship works.
You would be dumbfounded at how many people do not understand this. We normally call them Realtors.
You are actually better off buying during HIGH interest rate periods. Home prices will be low, savings will be high, and (in theory) monthly payments will be the same. As interest rates decline, your same monthly payment buys more house, so your pool of potential buyers becomes more inclined to pay more for your house. Also, as interest rates decline, people pull savings out and will likely spend it on houses. This boosts the monthly payment - a double win.
Buying homes at historic low interest rates, historic high prices, and historic lows in affordability is really a recepie for disaster. You will likely lose on every front.
That's why I say RE in the PNW region will lose at least 50% in nominal value, and in some cases 80% will be common.
Have fun.
so if interest rates zoom up (6% to 12%) home prices fall dramatically? you mean i wont be priced out forever?
seriously, given the unprecedented increased in RE values, will increased interest rates move prices down, or will "stickiness" keep prices up?
i guess thats the $64,000 question...
As interest rates rise, the seller has to demand from a buyer a higher monthly payment than they were willing to shell out. If the economy is slipping and interest rates are rising, people will not put the same money to a house as they did during the go-go years.
Just because a seller is having difficulty coming to terms with reality, does not mean he will eventually be made whole.
If he can sit on his house, then he becomes the defacto high bidder. If not, he will be forced by someone else to puke the house.
Any seller that thinks he is going to ride this out in 2-3years time is a moron. Selling pressures will be epic, and prices are going to come unglued.
Denial is not an economic strategy.
If I am sitting on a $500K house at the top of the market and want to sell, but the high bidder comes in at $420, I may hold out for a higher price. If my neighbor sells his house for $385K, and the next guy sells for $370, my guess is my concept of a $500K house will be shot to hell.
One thing that a good RE agent will tell you is that it is a disasterous strategy to attempt to chase a falling price. It is akin to chasing a ball down hill. You need to dive out in front and catch that ball. It is painful.
There is nothing "sticky" about an owner of an asset that wants to limit his damage in an obviously declining market. Once panic sets in, it is 'game on.'
Prices were not sticky on the way up, and they will eventually become "unstuck" on the way down.
Sticky only works if the owner reasonably thinks he can recover prior to his ability to carry the house runs out. With these prices and this type of financing, good luck. It will be shortlived.
IMO, the reason is that people just don't have enough equity to make this a reality. Banks are not going to allow massive amounts of short sales in a short amount of time, and foreclosures just don't happen quick enough to move the market that quickly.
It is MUCH easier to have a transaction on a house where the price went up, than to have a transaction on that same house when the price goes down. Easier transactions will happen quicker, get reflected in comps quicker, and feed the next easy transaction.
To all on this blog lurking and reading, be very careful when believing forecasts of 50-80%. Sure, that might happen, and the entire country may collapse but I think it's unlikely. Take all *opinions* with a grain of salt, including mine, and make your own judgement.
Look at Japan in the 1990s as a case study: real-estate prices kept falling yet interest rates were EXTREMELY low. Just because rates are low doesn't mean people will be able or willing to buy, or lenders would want to give them the money. Who wants to buy a home if they expect the prices to drop 5% a year for the next decade, or are afraid of losing their job any day?
What I do expect to see (above all else) is a MAJOR increase in the spread on rates for risky and safe loans. Anyone with poor credit will have to pay a much higher premium than they've been used to. Likewise, anyone wanting an "exotic" mortgage (i.e. with little money down, negative amortization, etc) will have to pay a very high rate. By contrast, people with excellent credit getting traditional loans with large down-payments may continue to enjoy very low interest rates.
In short, I don't think there is any direct correlation between interest rate levels and the boom/bust of the real-estate market.
In order for "good" borrowers to get low rates is for the overall interest rate environment to be very low. Rising defaults will eventually cause rising rates - for everyone.
Yes, I know my prediction of 50-80% discounts is completely out of the box. I admit that. Look at the underlying math.
Raise interest rates to double digits, pull 10-15% of the monthly payment out, raise property taxes, and require solid 20% down payments in an environment of no transported equity, a doozy of a recession, and a falling stock market, and you have serious problems.
There is NO WAY we get out of this by rolling property prices back to 04/05 levels - NO WAY! We have two huge speculative bubbles that need to be paid off, along with the misallocation of productive capital.
This has a very high liklihood of ending much worse than most predict. Most can't endorse the huge discounts because their historical perspective does not encompass that kind of carnage. They also fear what the general economy would look like in the event of a real financial fecal panini.
50-80% off? Yes, beware. Also, beware of those that cling to modest drops.
Every bubble ends in tears. The bigger the boom, the bigger the bust. There is NO WAY this speculative buying frenzy ends by rolling prices back to where they were when 80% of the valuation had already been added.
I don't see the connection. Why would rising defaults necessarily cause rising interest rates? That certainly wasn't true in Japan in the '90s (i.e. interest rates stayed very low while loans were going bad right left and centre). I am NOT saying that interest rates can't rise when defaults increase, I just don't see a direct link between the two.
You can have, as in Japan's example, the BOJ print so much Yen that interest rates collapsed in the face of rising risk. Perhaps that is why it took so long for them to recover.
Higher rates give lenders more room for a purchaser of loans to make a profit. When your rates are going out at 4%, it's tough to make money if things go against you.
I do buy that stikiness can be obliterated.
Any seller in a market that has moved against them has to evaluate two things on a constant basis:
1) - Will the market turn to my favor anytime soon?
2) - Do I have the ability to carry this asset that long?
If either of those two are not favorable, he will sell.
It makes no difference what is desired, just what is.
If a bank won't take a short sale, they are saying:
We can get a better price at a later date
We can carry the costs of that until that time.
Eventually, banks will be foreclosing because it is their best option.
Banks are regulated as to how much REO they can carry. This is to clear the books and start the next cycle upward.
I am of the opinion that the bulk of the recent buyers are leveraged beyond any historical benchmark, and any stikiness in the market only serves to prolong the time period prior to a recovery.
This is going to end worse than most imagine.
I completely agree that lenders will want to be much more richly compensated for risk as the real-estate markets turns down. However, lenders (and investors) will still like safe places to park there money. To that end, I think we could see super-safe mortgages (i.e. to people with incredible credit, and MASSIVE down-payments of 30% and an 800 credit score, perhaps) get very low interest rates, but mortgages that are a bit dodgier (only 10% down, say, and a 750 credit score) have a significantly higher rate.
Again, my main prediction is that the interest rate spread between ultra-prime, regular prime, and sub-prime will become huge.
Agreed.
I am of the belief that it has nothing to do with the borrower, but the underlying collateral that will cause interest rates to rise.
If housing can be shown to only lose 10-15% from the most insane runup in the history of the known universe, then you may have a point.
If housing can be shown to lose 30-50% in a quick and disorderly fashion (starting of a recession), then lenders are going to demand higher premiums for their money to cushion against that big of a loss.
It's like loaning money against Beanie Babies. Sure, back in '99 they would sell for $50each. I guess you could loan against them, but if they are shown to lose 95% of their value in 6 months, you are probably going to charge quite a bit more for that risk, regardless of who is the borrower.
I know houses have more uses and more values than BBs, but my point survives on the soundness of the collateral.
BBs are more liquid than homes, btw.
I think you are confusing the term 'sticky' with 'welded'. Your story about a seller not wanting to drop is exactly what makes housing sticky. Unlike other markets, there are probably not 100,000 houses with identical characteristics sitting around causing a normal market where the price can be clearly evaluated. If a seller sits on their price for a while despite lower offers, and then finally does drop the price that's what I would call a 'sticky' behavior.
Easier for WHOM? Ask someone who felt priced-out-forever and succumbed to a purchase. What you just said there amounts to saying that buying unaffordable homes are easier than selling overpriced homes for a bit of a loss.
I'd say both suck pretty hard. Why should we see the one happen all around us every day but never the other? A better question is this: why do priced-out-forever people feel pressured to buy now when we are theorizing here that sellers will never feel pressured to sell at a loss?
Priced out forever means you buy because you don't see it going down. Panic selling means it sucks so bad that you don't see the price going up. If the next 2 years make this look like a pretty decent year, we could be there, EASY. Turns priced out into "better sell while you can get out".
Of course, one major difference is that the bank doesn't force the priced-out buyer to stretch and buy. They will be forcing the non-paying seller to sell, though. And it doesn't matter that YOU are an upstanding, paying seller, the fact that buyers can buy your neighbor's forclosed home defines what you can get for yours, so do you want to move and take that new job in St. Louis, or don't you? It's a 25k annual pay raise for a one-time 15k haircut on the house. You could always rent it awhile and take a 30k haircut next year, instead. Whatcha gonna do?
I expect this will be no stickier than what the priced-out-and-buying-more-than-you-can-afford crowd has done. Ultimately, these are exactly the same people who will be having forced sales in a couple years, so there is no reason to think they won't panic-sell, since we've just watched them panic-buy for 5 years, right?
Many of us on SB are defacto "sticky buyers."
Back to my two factors for a seller:
1) Will the market improve for me?
2) Can I carry the costs until that happens?
Let's apply those to the buyer:
1) Will the market come back down to affordability?
2) Can I rent until that time?
Well...for #1, the "sticky buyers" are saying that it is possible. Some may never buy, but for those who want to buy, they are certainly not buying the POF premise. We are swimming upstream on this, as just about everyone believes that prices of RE never goes down. Most on this forum believe that the biggest correction we will see will be a rollback to prices that were present when this blog got its start. I think once we find the market breaking to a strong buyer's market, Eleua's Nuclear Winter for Housing will takeover.
#2. Can I hold on untiil the market comes to me? If I am paying 40% of what I would pay if I were a buyer, so I'm confident I can hold on. Over the past year, I seriously doubt my LL made any equity after their expenses of carrying the place.
So, here we are.
Both buyer and seller are looking at the market and placing their bets on how it will break. If my "bid" doesn't meet their "ask," there is no market, or the price is "sticky."
Phase 2: Who can hold on? The seller in today's market has high maintenance costs, finance costs, taxes, insurance, and vacancy risk. Also, as the market goes against them, their debt remains. They have banks that can force a sale if they can't meet their carrying costs. They also have to pay some bloodsucker 6% to unload the thing.
I have to pay rent, but it is less than PITI, so that isn't much of an incentive to bite the bullet. The LL pays the taxes and most of the insurance costs. I don't have any RE fees, maintenance fees, or assessments. My risks are limited to getting "Suzanned" and watching the market break away from me. However, if I have survived 1997-2007, I am pretty inured to markets getting away from me. My worst case scenario is I live in a rental at 40% of the total carrying cost.
I'm thinking I have more staying power than the seller. After watching this market topple in the past 18mos, I'm confident it will break my way.
I like my odds. I can be a "sticky" buyer.
My counterparty can be sticky, but not for long. At that point, the pressures to sell will be enormous, and the rout will be on.
When the myth of "real estate always goes up" gets shattered in the public consciousness, stickiness will be yesteryear's phenomenon.
Condition 1 will be violated for the seller (in a surprising and big way), and condition 2 will be right on their heels, as this runup has stretched owners to the limits of human indebtedness.
1-800-GET-ME-OUT
It may be sticky, but not for long.
Stupid is what stupid does.
The opposite is not true if that same house loses value and they have little or no equity and can't afford to keep it. They'll either have to arrange a short sale or foreclose. Both take time. After the transaction has gone through, the house sells for a bit of a loss, and a new "comp" price is set for future transactions.
I know someone that sold a house in San Diego. They just closed a few weeks ago. It was on the market for NINE months and they lowered the price FOUR times. They could have sold it in one month if they had lowered the price to the final price, but that would have seemed insane at the time. Once a seller gets a given price in their mind from comps, or from their realtor, any decrease from that price is a loss in their mind. It's odd, but people are reluctantly willing to carry a house for NINE months because they don't want to "lose" money by lowering the price.
In short, this is the stickiest situation since Sticky the stick insect got stuck on a sticky bun. (Blackadder quote, BTW)
Once the equity is gone, who cares?