Feb152016

Collapsing stock market may spawn a huge rally in real estate

Investors move out of stocks and into safe investments like government-backed mortgages, lowering rates and increasing housing demand.

Reinflation-viagraFor the last several years, the real estate market observers awaited the imminent rise in mortgage rates sure to trigger a price crash. While the spike from 3.5% to 4.5% in a six-week period in mid 2013 certainly removed the strong backwind from real estate, it didn’t signal the beginning of the end. On the contrary, since then mortgage rates have pushed back down near record lows, and despite high prices, housing is very payment affordable again.

Since mortgage rates are near record lows, the consensus opinion is that mortgage rates will eventually rise again. It’s very unlikely that 3.5% mortgage rates are permanent, but that being said, mortgage interest rates may not go up any time soon, so housing may prosper in 2016. The future of housing in inexorably tied to the course of mortgage interest rates.

Despite everyone’s expectation of rising mortgage rates, when the federal reserve raised the benchmark federal funds rate in December, rather than causing mortgage rates to go up, they have consistently trended lower. Why is that?

When the federal reserve raised rates, it signaled the end of cheap money that supported numerous Ponzi schemes and inflated asset values in nearly every asset class. While commodities trended lower for some time now, both the stock and bond markets continued rising — at least until the federal reserve took away the punch bowl.

Investors recognize the party is over, so they’ve been divesting themselves of stocks and risky bond holdings. Since they earn nothing in cash, most investors seek out safe havens to park their money. One of the safest havens is the 10-year Treasury note; thus investors piled in. Since Treasury Notes don’t provide much yield, and since mortgage-backed securities backed by the GSEs carry the same government guarantee, many investors bought these securities as a proxy for Treasury Notes with a superior yield. This money flowing into MBS pools drives down mortgage rates, which is why rates are so low today.

The crash of stock prices caused money to flow into mortgage-backed securities, driving down mortgage rates. The low mortgage rates are in turn fueling another price rally in real estate. This will continue as long as mortgage rates remain this low and the economy continues to prosper.

15-year mortgage rates drop below 3%

In the post, Bold California housing market predictions for 2016, I said, “If mortgage rates remain below 4.25%, both sales and house prices will rise next year. The economy is improving, and with an improving economy will come increased demand. If this demand is amplified by super-low rates, housing will do well.” Right now, that’s what’s happening.

If mortgage rates trend down toward 3.5% or manage to hit a new record low, house prices will rise 10% or more this year, and sales volumes will be higher.

Everyone will be really pissed when rates go up and the celebration comes to an abrupt end, but for now, the music is playing, and everyone’s enjoying the party.

House-in-Rose-Bowl-Parade

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