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Interest rates

 
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Sarum80



Joined: 25 May 2006
Posts: 15

PostPosted: Thu Aug 17, 2006 5:14 pm GMT    Post subject: Interest rates Reply with quote

Does anyone have any thoughts about interset rates? What I am wondering is if the 10yr stays below 5% and therefore mortgage rates do not rise much from where they are now, will housing prices stabilize and not drop much from here?
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admin
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Joined: 14 Jul 2005
Posts: 1826
Location: Greater Boston

PostPosted: Fri Aug 18, 2006 1:59 pm GMT    Post subject: Reply with quote

If the interest rates were the dominant factor, then yes, that could constrain price movement. However, while low interest rates were probably one of the main catalysts that instigated the boom so many years ago, I believe that at some point psychology took over. Price increases attracted the attention of people as a way to make money, which caused people to more aggressively pursue buying, which caused more price increases, and the feedback loop repeated itself until we had the feverish markets of 2004 and 2005 where sellers could very quickly get offers from multiple, anxious buyers, all well above asking price. Professor Shiller describes it better than I could in his book Irrational Exuberance (Second Edition).

Even if interest rates remain where they are now, there are several other factors which could dominate and lead to continued and accelerating price declines. Here are some of the more important ones that came to mind off the top of my head:


  • Massive inventory - Things just haven't been moving this year. The media likes to say there is a stalemate between buyers and sellers (and some even spin it as a "buyer's market"). Maybe there just aren't that many buyers left, though. The home ownership rate is at a historical high, so maybe the demand has been tapped out. Whatever the reason, it looks to me like the odds are stacked against the sellers and the glut of inventory will likely force them to reduce prices if they want to sell. Bear in mind that the inventory glut is a fairly recent occurrence and it will probably take awhile to affect the price.
  • ARM resets - A huge number of mortgages are going to start adjusting next year. Holders of these mortgages are still paying the low introductory rates set years ago, but their payments will spike next year. Those who stretched to buy may have no choice but to sell. They will be battling massive inventory and will have an urgency that will impede their position for price negotiation.
  • Speculative element being purged - To the extent that prices were being driven up and propped up by speculation in the past few years, this support is in the process of being removed now. Speculators are trying to get out and nobody is going to replace them in the near future. Not only will this remove the previous support that they lent to prices, but it will actually push prices down as they add to the inventory.
  • Changing psychology - There is no longer a fear of needing to buy now or risk losing out (missing out on appreciation or missing out by being priced out forever). The psychology has just started to turn to fear of buying now and losing money, though I don't think this is the common sentiment just yet. Just as the irrational optimism pushed prices up over the last several years, at some point we could very well see irrational pessimism pushing prices lower than they should be (though we aren't even close yet).
  • Population and job declines - It doesn't get any more fundamental than this. The population and job declines of the last few years should have brought housing prices down in Massachusetts - instead, prices went up. Eventually, this reality must be factored in.


Returning to the subject of interest rates, another thing to keep in mind is that increases from the Fed take awhile to work their way through the system. True, the effect on mortgage rates is pretty quick. It does affect sales volume as well, though, and that could take much longer to filter into prices as sellers may try to ignore the increase in inventory and treat it as a temporary anomaly.

I also think that interest rates may need to be raised further in order to fight inflation. Those who argue that the government is systematically underreporting inflation do have some interesting points, and it does concern me even if I'm not in entire agreement as to the magnitude. Energy and food prices, which are excluded from the core inflation that the Fed is fond of using, have been rising faster than other items. If the higher energy and food prices eventually feed back into the price of the items in the core basket, and I do expect that to happen eventually, then the Fed will need to raise rates in order to fight the inflation which really started years ago. This is all conjecture, though - rates could certainly remain steady.

- admin
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john p



Joined: 10 Mar 2006
Posts: 1820

PostPosted: Fri Aug 18, 2006 7:49 pm GMT    Post subject: great question/answer Reply with quote

What is interesting is how macro, meso, and micro economics play into the negotiations of a very small segment of our population: home buyers and home sellers. As Admin described, the factor of interest gives people an indicator about whether the tide is going in or out.

Interest rates affect people differently during different stages of the buying/selling process. At first, if a buyer is just begining to consider to buy, it provides the inertia to get going before rates get out of control or to not even begin to look because the best deals may be in a year or so if they think rates are going to drop... In the middle stages of buying, it helps them pin down their price range and affordability and zero in on the target neighborhoods/towns because the rate is a contributing factor in affordability. At the offer stage, it affects the final percentage or two. After the P&S, when you're locking rates, you're watching the 10 year yield every half an hour and you're chewing your nails off and pulling hairs out (Vegas time)...

During the boom, at every stage, all systems were go (everything told you to pull the trigger). Now, the inertia is stop and go, up and down with the overall trend moving downward. It's a bit turbulent and stressful to look during these times. Further, buying a house does take a small chapter from your life and to have to deal during turbulent times makes this chapter more of an unwanted roller coaster ride. Good negotiators can argue one set of points one day and the opposite set of points the next so a mixed market offers lots of opportunities for them. They buy from the nervous nellies and sell to the nervous nellies. One group is nervous about the collapse and the next about the bubble and interest growing. Perception is reality and because there is a variety of perception we live in a variety of realities. You need to shop around to the reality that suits your needs. This standoff between buyers and sellers now is due to buyers observing more transactions (realities) of steep discounts and why would they pull the trigger if there are opportunies out there if they are just patient. If rates stabilize or lower it just buys them more time to hunt.

If the interest rates plateau or drop, it creates a bit of sunlight for the sellers (provided that the rate is lower than when they put their home on the market.) Again, people will use whatever bit of data that helps them in the negotiations in the final transaction. In the middle stages, if the interest rate lowers it may make people start to look at houses at a higher price range because it increases their affordablity. If interest rates lower, it actually may make more new buyers wait altogether because again, without the incentive of interest rates rising, and rates lowering with house prices dropping, first time buyers will just wait until they feel that the market has bottomed out. The last twist related to interest is the comparitive cost of capital. If someone wants to trade to a larger or smaller home, they have to absorb transaction costs and a premium of interest payments due to the higher interest rate. If rates lower you will have a growing increase in this segment of buyers. The higher the rate goes, the fewer people will want to move because they will lose their 5% mortgage/cost of capital.

So, in order to understand how the macro, meso affect your micro (purchase), you need to understand all of the sellers in your price range. You need to know WHO is selling every house your interested in. Within your range get a sense of who is a serious seller, who is motivated, who has already bought a house, how long the house has been on the market, who has been transferred, etc. If a town has a large employer that has a big layoff it will affect their market. When EMC boomed, Hopkinton flourished. If EMC tanks a bit, so will Hopkinton. The other funny thing I'm hearing is how some towns are like the "blue-chip" stocks. It's true that some towns are close to lots of industry and if one sector gets hit it won't hurt the overall health of the market. The thing is that even the blue chip stocks dropped sharply after 9/11. Housing was a financial sanctuary from the stock market. Blue chip growth isn't always tied to fundamentals and when they become too expensive they too see price corrections. The "blue chip" communities usually have older housing stock and to heat these old buildings is going to cost more than any decrease in interest. When you weigh heating, parking , commuting costs, local taxes, property evaluations, etc. the interest rate is a mid-level factor. If all of these other factors rise steeply, the deduction in interest rate might get dilluted as far as an incentive to trade. The last factor is that if everyone is house poor, they become financially bonded and don't have money to go out to dinner or for a show or to buy a snowmobile, boat etc. So the snowmobile salesman needs to downsize etc. The hangover from the high cost of housing has really yet to hit us. When we don't have lots of money floating around because we're house poor it will slow down the local markets and hit different segments. When people get squeezed they will push their bosses for higher salaries. If this happens we'll get inflation which will increase the interest rate. This dip in interest rate was tied to the recent poor employment data. If it is a hot job market, wages go up and you risk inflation. If you make the cost of capital expensive, companies dial back in their expansion plans and they conserve and hire less. The FED is trying to regulate this. Newsflash to Massachusetts residents: The rest of the country is marching to a different economic drum. We need to filter and adjust national data to our own.

In the end, however, all that matters is whether the person who wants to sell or buy your house is on the same page with your outlook and value of the price being offered. At this point, it doesn't make sense to deal with someone that isn't a motivated seller.
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Renting and loving it
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PostPosted: Sun Aug 20, 2006 12:21 pm GMT    Post subject: Banks and Inflation Reply with quote

I believe the true sign that the Real Estate is correcting is there will be bank failures. Every major regional Real Estate correction has correlated with trouble for Banks.
Remember the Bank of New England or the S&L crisis. Owning Real Estate in New England and Texas at these times was a nightmare. Banks make a large amount of money from Mortgages and buying-selling Mortgage Backed securities. At this point in the Real Estate cycle banks are holding a lot of paper backed by mortgages. These investments (?) start to under perform has the Real Estate cycle gets long in the tooth.

If inflation forces the Federal Reserve to increase rates the Banks holding Mortgage Backed Securities will see the market for this paper vanish. Inflation is more than just food and energy. Most home owners have seen their Real Estate property taxes climb due to increasing Town salaries and Healthcare costs.
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ryanu



Joined: 26 Aug 2006
Posts: 2
Location: Mesa, AZ

PostPosted: Sat Aug 26, 2006 8:59 pm GMT    Post subject: Reply with quote

I have heard this groupthink theory quite a bit online. As a loan officer it is my experience that buyers are payment sensitive. They don't care about how much a home costs or what their interest rate is going to come in at. They only care about one thing... Their monthly payment.
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admin
Site Admin


Joined: 14 Jul 2005
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Location: Greater Boston

PostPosted: Sun Aug 27, 2006 2:24 pm GMT    Post subject: Reply with quote

Quote:
I have heard this groupthink theory quite a bit online. As a loan officer it is my experience that buyers are payment sensitive. They don't care about how much a home costs or what their interest rate is going to come in at. They only care about one thing... Their monthly payment.


That doesn't seem like a safe way of looking at it (which isn't to say that it isn't how most people do it). The purchase price is very important when it comes time to sell the house again. If the majority is stretching to make a certain monthly payment now when interest rates are still abnormally low, as interest rates return to normal new buyers stretching to make the same payments will be able to finance less and prices will necessarily fall. You therefore put yourself in danger of losing money on your house when it comes time to sell again if you substitute attractiveness of monthly payments for an appropriate analysis of whether the price is supported by fundamentals.

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john p



Joined: 10 Mar 2006
Posts: 1820

PostPosted: Mon Aug 28, 2006 5:15 pm GMT    Post subject: you're both right Reply with quote

Ryan and Admin, you are both right. The market is driven a lot by what joe-sixpack thinks i.e. it all being about monthly payment. The smart people who are in the minority understand that there is more to it than just that. Reality is that smart people need to operate amongst a population of boneheads. The boneheads can only set the agenda for so long. The circuit breaker in this is the banks that absorb the risk when they underwrite mortgages. Wait until you see bank appraisers writing up appraisals under the agreed prices. Let me know if any of you see this sort of thing happening. What would happen if this happened?
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PostPosted: Sat Sep 02, 2006 12:14 am GMT    Post subject: Reply with quote

Going forward, interest rates are the biggest factor. My guess going forward is contingent on the rates: A return to previous low rates - soft landing, at present rates - painful correction, at higher rates - disaster.
So my guess is on a very painful correction. Luckily we decided not to purchase in Boston.
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