House prices could fall and the cost of home ownership could still go up

Lower house prices due to higher mortgage rates still result in a higher cost of home ownership.

housing-stagflationEveryone shopping for a home wants to see lower prices. For most products, paying less for it means the buyer has more money available to purchase other goods and services, but with houses this isn’t necessarily the case. Most people borrow money to buy a house — a great deal of money, 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 thereby bid to buy a house. (See: Your neighbor’s debt creates your home equity)

When mortgage rates go up, the cost of borrowing will increase, 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 cost of borrowing rises faster than wages, then future buyers will not be able 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.

housing_double_dipIn 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 finally start to rise, people will still 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 a rising cost of ownership, the worst of both worlds in residential real estate. In the meantime, mortgage interest rates are still below 4%, and housing is starting 2016 strong.

Home Prices Rise, Aided by Strong Hiring Growth


WASHINGTON — Home prices in the United States increased at a faster clip in November, propelled by solid hiring growth, low mortgage rates and a shortage of houses on the market.


The Standard & Poor’s/Case-Shiller 20-city home price index rose 5.8 percent from a year ago, after a 5.5 percent pace in October, according to a report on Tuesday. …

Home values nationwide have nearly recovered reflated from their July 2006 peak, as the real estate market has slowly recovered from the housing crash that set off the recession. But several metro areas have fully rebounded reflated from the downturn. Four of them — Dallas, Denver, San Francisco and Portland, Ore. — have either matched or eclipsed their highs. And Charlotte, N.C., is less than 1 percent below its previous high. …

(See: Irvine home prices surpass housing bubble peak)hid_the_houses

 More Americans have been able to buy homes as employers have added 2.7 million jobs and borrowing costs remain low. But the number of available listings has fallen 3.8 percent from a year ago, causing tight inventories that have sent prices up.

The rising home values and limited selection could ultimately deter sales growth in 2016. …

The challenges caused by rising home values have been offset by falling mortgage rates in recent weeks.

How long can that continue? Will mortgage rates keep falling forever? (See: Mortgage interest rates may not go up, housing may prosper in 2016)

The mortgage buyer Freddie Mac said the average rate on a 30-year fixed-rate mortgage declined to 3.81 percent last week, from 3.92 percent a week earlier. Rates have historically averaged 6 percent, meaning that interest expenses are relatively low.

Will rates eventually revert to the mean? Probably, but it may take a very long time.

If the housing bubble burst is caused by rising mortgage rates, future homebuyers may pay a lower price, but they won’t enjoy a commensurate lower cost of ownership due to rising mortgage rates.

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.


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