Feb152017
Will rising mortgage rates lead to housing stagflation?
Lower house prices due to higher mortgage rates still result in a higher cost of home ownership.
Everyone shopping for a home wants to see lower prices. For most products, paying less for it means the buyer keeps more money to purchase other goods and services, but with houses, this isn’t necessarily the case. Most people borrow a great deal of money to buy a house, often 80% to 96.5% of the purchase price. In fact, the cost of borrowing money is largely what determines how much someone can borrow and bid to buy a house. (See: Your neighbor’s debt creates your home equity)
When mortgage rates go up, the cost of borrowing increases, and unless wages rise considerably, the cost of borrowing will increase faster than wages go up. (See: Will rising wages offset the impact of rising mortgage rates?)
If the borrowing costs rise faster than wages, then future buyers will be unable to borrow the large sums today’s buyers can borrow; thus home price appreciation will slow (or perhaps even reverse). It’s entirely possible that buyers to wait to buy later may pay less money, but will that provide them any real benefit?
Some potential homebuyers remain on the sidelines hoping today’s reflated housing bubble prices will come down. The people sitting on the sidelines believe lower prices will bring with it a lower cost of ownership, but it won’t work out that way. Even if prices fall due to rising mortgage rates, the cost of ownership will continue to rise.
In the real world, particularly in Coastal California where supply is tight, people borrow to the maximum limit allowable to obtain the highest quality of housing they can. There is no excess affordability to provide any buffer to the shock of rising mortgage rates.
When mortgage rates rise, people will continue to borrow to the limit of their income, so the cost of ownership will not fall. In fact, the cost of ownership will continue rising with wages, so the housing market will continue to endure high inflation.
Perhaps all-cash buyers will reap the benefits of lower house prices, but not necessarily. If house prices fall due to higher interest rates, all-cash buyers will pursue other investment opportunities providing higher risk-adjusted returns than residential real estate. So while all-cash buyers may get a better deal, they may not want to buy houses because they can find superior returns elsewhere.
What we may see over the course of several years is weak or falling home prices and rising ownership costs, the worst of both worlds in residential real estate.
Fed hike in March may be on table
Paul Davidson, USA TODAY 6:30 a.m. ET Feb. 11, 2017
Ho-hum. Another Federal Reserve meeting is slated for mid-March, but almost no one is expecting the central bank to raise interest rates again after lifting them in December for the first time in a year.
Don’t be so sure.
In a recent interview with Bloomberg TV, San Francisco Federal Reserve President John Williams suggested a March hike isn’t off the table. And Chicago Fed chief Charles Evans, a dove who typically refers to keep rates low to stimulate the economy, said he’s still officially forecasting two rate increases this year but could be comfortable with three.
In December, when the Fed lifted its benchmark rate for the first time in a year, central bank policymakers raised their median forecast to three hikes in 2017, up from their estimate of two previously. Many economists say those moves will be backloaded to the second half of the year, when President Trump’s proposed fiscal stimulus could begin to juice growth.
Does anyone really think Trump will propose or pass a big fiscal stimulus that will stimulate the economy this year? So far, I haven’t seen the proposal. In 2009 when Obama tried to do the same thing, the Republicans opposed it. At the time, the economy really needed the stimulus. Now, not so much. Why would fiscal conservatives in the Republican party go along with a big stimulus package? The hypocrisy would be obvious, even to their partisan supporters.
When Obama went to implement his stimulus package, he found a lack of shovel-ready projects to spend money on. Are there more projects waiting today? I doubt it. Even if Trump gets his Republican allies to pass a stimulus package, actually spending the money may not happen as quickly as everyone hopes.
Fed fund futures give just a 9% chance of a rate increase in March, but 50% odds for June.
Fed Chair Janet Yellen, however, also has said the generally falling unemployment rate, now at 4.8%, calls for pushing up rates to head off inflation as employers bid up wages to attract fewer available workers.
Actually, a little wage inflation would be the best thing we could do for growth. It would be far more effective that a wasteful government spending program.
And employment growth in January was strong, with 227,000 jobs added. A March increase would allow the Fed to spread out the three potential hikes throughout the year. Her testimony before a Senate committee Tuesday and a House panel Wednesday could clarify the outlook.
I rather doubt three rate hikes is going to happen.
Wait for price deflation?
I became well-known for advising people to wait out the deflation of the housing bubble of the 00s, so if I believed lower prices would benefit anyone, I would advise waiting, but that’s not the case today. The conditions during the last bubble were different in a good way for buyers. That housing bubble was going to deflate because millions of foreclosures flooded the market with supply and lowered both the price and the cost of ownership. That won’t happen during the deflation of the reflation recovery (aka housing stagflation) because lenders won’t flood the market with supply, and mortgage rates will go up, not down.
If buyers have no reason to expect a lower cost of ownership, they gain no real benefit from waiting. Perhaps waiting reduces their risk of taking a loss at resale, but it does nothing to make owning any cheaper.
You don’t address getting better quality housing at lower price, regardless of the interest portion of the payment mix. Then there’s the mortgage interest deduction. It’s a net higher effective subsidy when rates are higher. If investors pull out of housing asset class to chase yields elsewhere (completely plausible) that puts downward pressure on prices which is even better for buyers.
You won’t necessarily get a better house at a lower price because the cost of the mortgage makes the less expensive house just as expensive to own.
The higher mortgage subsidy is a plus, but you also have a larger opportunity cost on a down payment. The money tied up in the down payment could have been invested elsewhere.
If the drop in home prices more than offsets the rising cost of ownership, which is feasible if investors pull out, then the lower price could also have a lower cost of ownership despite rising rates. However, I consider that unlikely because even if investors bail, the owner-occupants will likely stay put and try to weather the storm.
Taking a loss at resale is a cost of ownership!
These Graphs Explain Why California’s Property-Tax Regime Is the Worst
Pro-growth activists in exorbitantly expensive places like San Francisco often argue that the state should make more efforts to pre-empt local land-use policies that restrict housing construction and drive up prices. That’s more or less what Gov. Jerry Brown proposed earlier this year with a bill to streamline the approval of multifamily projects that complied with local zoning. (His proposal is dead, unfortunately.)
Prop 13 fixed the statewide property tax rate at 1 percent, and applied that millage to purchase price (plus a small annual rate of increase), rather than market value. That means that as home values have skyrocketed in California, property taxes have not. If you bought a home in California in 1980, the difference between the market value and assessed value of your home is, on average, $300,000. It has paid to stay put. Look how uneven tax collection rates are in one neighborhood of Los Angeles:
That amounts to a giant, rent-control-size subsidy to Californians who bought their homes a long time ago. (It’s particularly sweet for Californians with big, expensive houses. Tax relief from Prop 13 aligns almost perfectly with household income.) It’s one reason why the proportion of the state’s properties that change hands each year fell from 16 percent in 1977 to less than 6 in 2014. It’s a seller’s market.
More anecdotally, longtime homeowners are among the most stringent opponents of new housing. They’re the ones lining up behind L.A.’s Neighborhood Integrity Initiative.
Obviously, Prop 13 changed the way cities raise money. Property tax went from 90 percent of local revenue in the ’70s to less than two-thirds today. What took its place? Hotel taxes, utility taxes, and new fees. Mostly, the highly regressive sales tax.
You can see that this creates some incentives for city planners. Zoning for a hotel, auto dealers, or strip malls is going to generate a lot more money than setting aside land for residential.
Causation meet correlation. How does a control group of, say, the other 49 states compare?
Looks like the trend holds everywhere, so Prop 13 is not the culprit.
The trend holds everywhere, but the trend is exacerbated here because the low tax rates prevent these homes from being recycled so that younger people can buy them.
I think one’s attitude about proposition 13 depends a great deal on where you are in your life cycle. If I were 30, proposition 13 would anger me. Now that I’m about to turn 50, the idea of locking in a low property tax rate sounds appealing.
The logic fail here is obvious when you compare to other high cost areas of the country that don’t have Prop 13. The lack of a Prop 13 in New York, New Jersey, Chicago, Seattle, and Portland has not stopped the tide of higher prices and lower ownership for younger generations. Forcing old people to vacate their homes is a novel idea, but there is no evidence that it actually leads to lower prices.
I’ve always supported Prop 13 since I was voting age, long before I would have benefited from it. The idea that people’s taxes should go up based on a make believe opinion of value has always seemed wrong to me. The abuse around those types of taxing schemes in other states is rampant.
My aunt in the Midwest literally had a tax assessor snooping around her property and looking in the windows before she threatened to call the police. Anything to determine if her assessment should be raised including prying into her personal life. How sick is that? It sounds unbelievable, but that is the reality of taxing authorities in many areas around the country. They wield a disproportionate amount of power to extract dollars from your pocket, and your right to challenge them is often limited, outside of going to court. Who wants to do that?
Exactly, you are insane if you think repealing prop 13 would lead to lower taxes.
Taxes would go up dramatically and schools and services would not improve.
If you don’t believe this… move and experience $18K in property taxes on a $600K home like I have before.
Conventionally Financed New Home Sales Reach Nine-year High in 2016
NAHB analysis of the most recent Quarterly Sales by Price and Financing published by the Census Bureau reveals that 70.8% of new home sales in 2016 were financed with conventional products—up from the most recent trough of 58.5% in 2010. Conversely, over the same period, the share of new home sales financed with FHA mortgages has fallen from 25.1% to 15.7%. FHA loan market share tends to decrease as economic conditions improve and lending conditions ease, as a larger share of buyers qualify for conventional loans.
Census data and NAHB calculations show that new home sales backed by FHA products fell to 18,000 (-2,000) in the fourth quarter of 2016, though market share held steady at 14%. Market share fell to 15% in the second quarter of 2013 after reaching a high of 28% in the first quarter of 2010, and has averaged 14.4% ever since.
I agree with your points here, I think eventually we will see a very 1990s recession.
I peg this most likely in 2019.
At some point I believe we will see a 1970s period with high inflation of housing and all things with high interest rates.
Interest rate cycles are very long.
Whoa.. You almost sound reasonable here. Are you feeling ok?
If you look closely, you will see the recent mortgage increases have triggered a buying panic in many areas. This is fact. But, the big question is what happens in about 6 months. The higher rates might slow the market down. You just can’t tell. But, you do not want to automatically think the frenzied buying activity taking place will continue as rates continue to increase.
Maybe below $750K
Over $1M appears very soft right now, and $800K-$1M isn’t much better.
I don’t think it has anything to do with mortgage rates.
At some point, these price points run out of buyers. While wages are relatively high in Orange County, we have far more homeowners who believe their houses are worth over $1,000,000 than we have people capable of paying those prices. As long as the supply is metered out slowly enough, prices can be sustained, but if we had anything approaching normal inventory, the over $800,000 market would be considerably weaker.
Fed’s Lacker calls for ‘significantly higher’ interest rates
Significantly higher interest rates are warranted, a Federal Reserve official said Tuesday in comments that reflect the breadth of debate at the central bank.
Richmond Fed President Jeffrey Lacker, who is retiring and isn’t a voting member of the Federal Open Market Committee, said that almost all policy rules are recommending higher interest rates. The Fed currently targets its federal-funds rate between 0.5% and 0.75% after making two hikes in a decade.
“Taking the range of plausible alternatives into account, my view is that, with unemployment at or below levels corresponding to maximum sustainable employment and with inflation very close to our announced target of 2%, significantly higher rates are warranted,” he said.
The risk of waiting is that an unanticipated rise in inflation pressures will rise, which in turn will force a quick increase in rates, he said. “Such rapid adjustments can be hard to calibrate, and they heighten the risk of overdoing it and sending the economy into an unnecessary recession,” he said.
Lacker has consistently been at the hawkish end of the Fed spectrum with respect to interest rates.
Facts 101 class is back in session.
*Housing is a proven boom/bust asset class.
*The trend is your friend until it isn’t = it’s a sellers market until it isn’t.
*A house with a mortgage is a liabilty, NOT an asset.
*A homedebtor is a renter; rents the capital needed to be a game-player.
*Any mortgage becomes toxic once the monthly pymnt can’t be made
*Home equity is a temporary credit that can be deleted.
*Home equity = unrealized paper gain, aka trapped/UNPRODUCTIVE.
*Tapping home equity is NOT a gain, it’s a DEBT.
*When markets aren’t real, neither is CONfidence.
*The aggregate bubble prices can NEVER be realized by selling
Class dismissed
The historic debt to equity ratio of the S&P500 is about 2.
The historic debt to equity ratio of the US housing market is about 1.5.
Let’s dumb it down to the basics for HBS, aka H’el-O Business School:
Assets = Liability + Equity
Same Fed game… talk about raising rates all year then creep up 1/4 point in December. I would be shocked if we get more than one increase this year but I do expect the game to continue and Fed-speak shift into overdrive.
If anything could push them to raise more than once, it would be this:
LABOR DEPARTMENT REPORTS LARGEST INCREASE IN CPI IN 4 YEARS
The Consumer Price Index increased 0.6% in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics
reported today. Over the last 12 months, the all items index rose 2.5% before seasonal adjustment.
The January increase was the largest seasonally adjusted all items increase since February 2013. A sharp rise in the gasoline index accounted for nearly half the increase, and advances in the indexes for shelter, apparel, and new
vehicles also were major contributors.
The energy index increased 4.0% in January as the gasoline index advanced 7.8% and the index for natural gas also increased. The food index, which had been unchanged for 6 consecutive months, increased 0.1%. The food at home index was unchanged, while the index for food away from home rose 0.4%.
The index for all items less food and energy rose 0.3% in January. Most of the major component indexes increased in January, with the indexes for apparel, new vehicles, motor vehicle insurance, and airline fares all rising 0.8% or more. The shelter index rose 0.2%, a smaller increase than in recent months.
The all items index rose 2.5% for the 12 months ending January, the largest 12-month increase since March 2012. The index for all items less food and energy rose 2.3% over the last 12 months, and the energy index increased 10.8%, its largest 12-month increase since November 2011. In contrast, the food index declined 0.2% over the last 12 months.
Thanks for the data points. I still don’t buy it. In the last 8 years the national debt and money supply have doubled and all they get is 2.5% with gasoline heading the way. The economy is still being HIGHLY stimulated and still extremely fragile. Global pressures are still strong. Talking about raising rates was generated the desired effects. Actually moving the rate a few notches up would be like pulling the rug out from under their ‘recovery’