The two biggest worries in housing today
The specter of rising mortgage interest rates or an end to the flow of foreign investment concerns speculators in US real estate.
Many investors in real estate worry that the current recovery may be coming to an end. Economic expansions usually don’t last as long as this one, so many people worry that we are due for another slowdown. The anxiety level among real estate investors is particularly high because so many of them were crushed during the last recession, and they would prefer to avoid that damage.
When pressed for reasons behind their anxiety, many can’t point to anything specific. The economy is growing, but not so fast as to suggest overheating, and few indicators suggest a recession is imminent. The housing market reports I publish reveal a fairly-priced housing market with steadily growing rents and gently rising prices, and home sales top last year’s levels. Those who articulate reasons for concern generally point to two factors: the flow of foreign investment and the prospect of rising mortgage rates.
While these are dangers to the market, both of these issues hung over the market for the last several years, and yet they continue to be a source of strength. Interest rates are near record lows, and foreign buyers keep buying, despite yearly forecasts from economists to the contrary.
Worry #1: The flow of foreign capital might slow or stop
Many Chinese investors consider Irvine, California, a safe haven where they can store their wealth far from the controlling hands of Chinese government officials. As a result of this perception, Chinese investors purchase a significant number of homes in Irvine — anecdotally, Chinese Nationals buy 80% of properties in some new home communities. In fact, Irvine homebuilders depend on Chinese buyers to purchase their overpriced houses, which becomes a problem when this flow of money dries up.
Chinese capital is an unstable source of investment, and it could reverse course in a moment based on policy changes in China. Investment capital from wealthy individuals in China is hot money escaping an unstable market, subject to the policy whims of an unpredictable totalitarian government. For now, the flow of money shows only a few signs of slowing down.
By Troy McMullen October 14
“To be honest, Chinese buyers have been flooding this market the past few years,” says Conlan, who has been selling homes in Seattle for more than 30 years. “Some of them buy homes sight unseen, while others travel here for a kind of real estate tourism and buy real estate after only one viewing.”
Seattle is not alone. For the fourth year in a row, buyers from China ranked first among foreign nationals purchasing property in the United States, according to a survey by the National Association of Realtors (NAR). U.S. home sales to Chinese nationals totaled $27.3 billion — exceeding the total dollar sales figure of the next four countries in the rankings combined, the survey showed.
Chinese investment in U.S. real estate could hit $50 billion by 2025, according to a report by the Rosen Consulting Group and the Asia Society.
Vancouver recently passed a tax on home sales to curb the flow of Chinese money into their city. Foreign investors priced out the local population, leading to a political backlash.
If foreign investors price out local California residents, wouldn’t we consider similar measures here?
In San Francisco Bay-area locations such as Palo Alto and Woodside, home prices have risen by double digits in the past three years, while the number of buyers from China has nearly doubled since 2012, says Penelope Huang, a broker with Re/Max Distinctive Properties. The increased demand is making the area one of the toughest for younger buyers, she says.
“Listings are snapped up in a week or sometimes less in this market,” she says. “That kind of pace of sales directly affects first-time buyers.”
Will the American Dream die because foreign investors overpay to become our landlords?
Factors that typically influence real estate sales in most places, such as income levels and the strength of local economies, do not mean as much when large numbers of outside buyers from places such as China invade a market, says Nela Richardson, chief economist at national realty brokerage Redfin. “Local fundamentals aren’t necessarily the driving factors when that happens,” Richardson says. “That affects buyers who live in these places and can lead to locals essentially being priced out of their own markets.”
We witnessed this same phenomenon here in the United States during the housing bubble. California equity locusts swarmed on sleepy second-home communities in places like Bend, Oregon, or Boise, Idaho, driving up prices for locals, leading to a devastating crash.
How is the Chinese invasion any different? They inflated a massive housing bubble that enriched many ordinary citizens with fake bubble equity. These people feverishly work to divest themselves from their own bubble and park their money in safe havens like Coastal California real estate, inflating our prices and forcing locals to pay much more.
Worry #2: Mortgage interest rates may rise
Real estate investors wisely concern themselves with mortgage interest rates because fewer home sales or lower prices will follow higher mortgage interest rates. Assuming a consistent payment, higher mortgage rates decrease the size of the loan and reduce the amount borrowers can bid on real estate. While it is possible the federal reserve may print enough money to spark wage inflation, higher worker pay is almost certain to come later than rising mortgage rates. Therefore, if rising mortgage rates results in smaller loan balances, then either sales volumes will go down, or house prices will go down, or perhaps some combination of both. This isn’t speculation; it’s basic math.
However, mortgage interest rates may not go up, and housing may continue to prosper. For the last several years now, pretty much everyone predicted interest rates would rise. Year after year, we were told mortgage rates would rise to 5% and then to 6% shortly thereafter. Every year the pundits were wrong.
Like many others who expected interest rates to rise, I accept that I was wrong. I now believe that low mortgage rates may be with us for a very long time. Mortgage interest rates can’t rise significantly unless we have a huge increase in demand for housing, which doesn’t seem likely. Realtors currently peddle the fantasy that first-time homebuyers will flood the market next year. I wouldn’t count on it. Millennials still carry excessive debt burdens and struggle with low wages.
Written by Alex Starace on October 20, 2016
[That headline should win an award for the least risky and most hedged prediction of 2016.]
Mortgage rates were up this week, averaging 3.52 percent for a 30-year, fixed-rate loan, up from 3.47 percent last week. This is the first time in four months the rate has been above 3.50 percent. Last year at this time, rates were 3.70 percent, according to Freddie Mac.
A consensus is growing on what may happen in the near future with interest rates.
Any consensus of economists is likely incorrect.
What’s Expected in the Next Two Months?
People of all political stripes agree that the madness of this election season is worth waiting out. Janet Yellen and crew (a group also known as the Federal Open Market Committee, or FOMC) meet mere days before the election, on November 2, to discuss whether they’ll raise the Federal funds rate.
Heavy odds are they won’t. As of publication, there’s a 92.8 percent chance they’ll stay the same.
Instead, talk is on a recent run of okay-but-not-spectacular reports, that aren’t where economists hoped they’d be, but that might be good enough for the Federal Reserve to raise rates in December. For example, the most recent jobs report was described as “stubbornly average” by Redfin chief economist Nela Richardson, while economist Diane Swonk described it as “solid, not spectacular.”
Continuing this theme, Tuesday’s consumer price index was “in line with expectations,” according to CNBC, and revealed that year-over-year inflation was 1.5 percent, the highest it’s been since October 2014. That’s inching closer to the two percent the FOMC deems ideal, and a number that Bloomberg notes is consistent with a raise in rates in the coming holiday season.
So we went from a predicted three or four interest rates hikes in 2016 to a possible one — and that might not occur either. Hmmm….
Does it seem likely that interest rates will rise much next year?