I was listening to a financial talk show on the radio the other day; the host was going nuts over an upcoming Treasury auction where over $140 Billion in 2, 5, and 7 year notes were going to be auctioned. This would represent the most auctioned at one time ever, and would be on top of $60+ Billion in notes auctioned the week before.

This got me to thinking about how much debt was out there and ultimately where current mortgage rates were and what direction they were headed in.  Here is what I found… 

The State of Debt

In my search I ran across this very sobering set of statistics about who holds the most US debt… take a look at the data, and if you’re not concerned about where interest rates and inflation are heading, then you must be asleep.

Scary, scary stuff… and as one of the comments indicates; that last $4.75 Trillion is the Treasury printing money, buying its notes with the funny money and putting the funny money into the system. That ’s called monetizing your debt — just like borrowing from your credit card.  We know it didn’t work for consumers… surely the Government is smarter that a bunch of uneducated consumers?  NOT!

OK… what does all of this have to do with mortgage interest rates?  Perhaps a lot.

The Impact on Mortgage Interest Rates

With all of these notes selling, I was extremely surprised to see that mortgage rates have been dropping from their summer highs of over 5.5% and are now hovering around 5%. And, many are predicting that these rates may hit historical lows by the end of the year.  This really is great short term news, as it means home buyers are getting a double assist when purchasing a home today — low mortgage rates, mostly backed by the FHA, and the $8,000 first time homebuyer tax credit.

However, due to the high level of Treasury sales, most reasonable people would see that in order to get investors to continue to buy these bonds the yield is going to have to be increased, and the Fed may just have the answer.  Assuming their appetite for funds doesn’t get in the way, the Fed plans to stop buying 10 year notes.  If they in fact do this, they will remove themselves from the equation and the yield curve should start to trend upward from its current 3.5% position.

Since mortgage rates track to the yield curve and are usually separated by 1.5 basis points (mortgage rates higher then yield) in spite of what others may be predicting, we can expect mortgage rates to head higher and probably top the 6% mark later this year.

Will it happen?

While I am not a betting man… I can’t find a scenario where mortgage interest rates can stay at their current level. Plan accordingly.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Mortgage Interest Rates: Where Are They Heading?

Even the most bearish economist is predicting that commercial real estate prices will fall up to 40 percent from peak to trough. However, the data released yesterday from Moody’s Investor Service shows that in April commercial property prices plummeted a record 8.6 percent. According to Moody’s data, commercial property prices fell a total of 29.5 percent from their highs in 2007. This leaves another 10 percent drop in prices if the most bearish economists are correct. In my opinion, much of this drop was due to a speculative credit bubble that caused commercial property buyers to purchase properties that would never produce a positive cash flow, even assuming a strong economy and strong demand for commercial real estate.

I believe that most of the declines in commercial property prices that can be attributed to the credit bubble have mostly taken their toll on prices. But, I surmise that we could experience an even greater decline in commercial property prices due the fact that the economy is fundamentally unsound. If one closely examines the fundamentals of supply and demand for the commercial property sector, the prospects for continued price declines becomes readily apparent, especially in the retail and office building sectors of commercial real estate.

Background to a Crisis

During the speculative credit bubble, developers built many more office buildings and retail stores than could possibly be sustained. Now that unemployment is in the double digits and major economic sectors like the automotive industries are going bankrupt there is less demand for commercial property. There have been many large, well known, retail brands either going bankrupt or severely cutting back growth projections. In a small city, near where I live, there are at least fifteen Starbucks. How many Starbucks stores can one small city support? Circuit city is out of business, Brandsmart may be next. Car dealerships are closing their doors around the country. These are all commercial real estate tenants whose absence can’t easily be filled. The list goes on and on. If so many large retailers are going out of business or curtailing operations then there will be even less demand for all of the vacant commercial retail space.

Commercial Real Estate Breakdown & Predictions

As local, state and federal governments go deeper into debt they will be increasing taxes even further on businesses and property owners. This means higher taxes for the owners of commercial real estate. If the costs to hold a property increase, then its intrinsic value must decrease.

I would challenge the 40 percent figure and would argue that prices could drop even more due to the dismal state of the economy at large. I would go the record to say that the commercial property sector could see real price declines of up to 70 percent from peak to trough. The worst might still be ahead of us.

Source: Reuters
Photo Credit: strangelv

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This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Is This the Bottom for Commercial Real Estate Prices?

The  mortgage interest deduction, which has long been an untouchable pillar of the tax code for homeowners, is on the chopping block in President Obama’s 2010 budget proposal. The President wants to reform our healthcare system here in America and is proposing the mortgage interest deduction be capped at 28%. This would affect homeowners making $208,850 over the 2009 married filing jointly tax bracket income calculations.  The mortgage interest deduction has been in place since we had an income tax code. All interest used to be deductible but over the years, congress has whittled down interest deductions for non-businesses to only the mortgage interest deduction. That was done with the Tax Reform Act of 1986.  Several groups are up in arms about this proposal as the mortgage deduction is seen as a help for lower income folks to buy a home. Many economists however disagree that the home mortgage interest is all it is cracked up to be. In a recent blog post in the New York Times Economix Blog,  Harvard University Economics Professor Edward Glazer makes some salient points about the flaws of the mortgage deduction. He outlines 5 problems with the “conventional wisdom” of the deduction as a savior of the working class hero:

Problem #1: Subsidizing interest payments encourages people to leverage themselves to the hilt to bet on housing markets. The size of the tax benefit is proportional to your debt. The deduction essentially encourages us to make leveraged bets on the swings of the housing market. That leverage means that housing price swings can easily wipe people out. We are currently experiencing the consequences of subsidizing gambles on housing.

Problem #2: The deduction pushes up prices in places where the supply of new homes is constrained, as it is in many coastal markets. Economics 101 teaches us that if we subsidize demand where supply is inelastic then the only effect is to make prices go up. Housing supply is pretty constrained in places like New York City because of land-use restrictions and lack of land. In these places, the deduction doesn’t make housing more affordable. It just transfers money from buyers to sellers, and that makes little sense.

Problem #3: The deduction is wildly regressive. The tax savings for households earning more than $250,000 is 10 times the tax savings for households earning between $40,000 and $75,000 a year, according to recent research by James Poterba and Todd Sinai.

If there ever was a case for small-government egalitarianism, then this is it. Eliminating the home mortgage deduction and replacing it with an across-the-board tax cut would equalize after-tax incomes without a single new government program.

Problem #4: The deduction encourages people to buy larger, single-family detached homes, and that increases carbon emissions and pushes people out of cities. The deduction encourages people to buy more expensive homes, which are generally bigger homes.

Bigger homes use more energy. The deduction is therefore implicitly urging Americans to run higher electricity bills and spend more on home heating. If global warming is a serious problem, then the government should be encouraging us to live in smaller, not bigger, dwellings.

Problem #5: The home mortgage interest deduction is poorly designed to encourage homeownership, which is, after all, the alleged desideratum. Much of the interest deduction’s benefits go to richer Americans who are likely to own homes in any case.

Poorer people who are on the margin of buying and renting often don’t even itemize. My own research in this area found that when the value of the interest deduction rose, during periods of high inflation, there was no observable increase in the homeownership rate.

If the goal of the deduction is just to increase homeownership, then it would make far more sense just to give a flat tax credit to people who buy homes. If the credit was independent of home value, then this would eliminate the incentive to buy bigger homes. If the credit was independent of borrowing, then this would decrease the incentive to over-borrow.

I would like to hear from the Bigger Pockets community about their feelings on the mortgage deduction.What do you think?  Is it truly something we can’t live without?

(Image Courtesy of: Arizona Mortgage News)

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Mortgage Interest Deduction in Jeopardy

So, a few weeks back I wrote a post “How Far Down Can My Savings Go For a Down Payment” discussing just how much first-time home buyers need to have in the bank for a down payment. And I received a few great comments. One in particular asked, “What happened to 15 – 20% equity…?”

This got me thinking. With FHA loans allowing just 3.5% down payments on home purchases, is this too low? As we save money for a down payment on our first home should we but aiming to contribute more to our down payment — possibly to the tune of 20% down?

Sidebar: A buddy of ours was over at our apartment and we were discussing home purchases. When he bought his home 3 years ago, he put 30K down. Now… based on the new value of their home, if they wanted to sell they’d be upside-down. That 30K is virtually gone.

So, here’s my question. With more of the country’s work force falling out at rapid rates and seemingly slamming housing values further into the ground, is it still wise to put the largest down payment possible into your home? Could it be a better financial decision to put 3.5% down, and put the remaining amount in a safe interest-bearing account — even a CD — until you sell the home? Or, if the home needs repairs, since HELOCs are no longer available is it best to just preserve your money in a low interest-earning savings account so that you can guarantee you have something to draw from. 

The Drawbacks

I suppose PMI would factor into the decision. PMI could be higher with a lower down payment. As where a 20% down payment would eliminate PMI payments completely.

And your interest rate could factor into your down payment decision. Some lenders charge higher interest rates for larger loan amounts. But, here’s another challenge: Could it be more beneficial to purchase points upfront to buy down your rate rather than contribute a heavier down payment? Particularly when that down payment could dissipate pretty quickly.

Another thought: Okay, so what if your home value does decline beyond your 3.5% down payment and you need to sell. You’re upside-down, but now, at an even greater level than you would’ve been had you contributed a higher down payment. With a greater down payment, you would’ve at least broken even. I hear you. But let’s assume you put an additional 6.5% into a CD (or something similar) and you earned a decent amount of interest on it during the time you’ve lived in your house. You still have the money to bring to the table at closing to break even, but now you have more of it thanks to the interest you’ve earned. Was it worth it?

Right now the number of potential home loan clients turned away for a failed-value appraisal is enough to make me at least raise the question.

Frankly, I don’t have the answers. Interest rates, home values and monthly mortgage payments are based on a myriad of factors that could vary the true answer on a case by case basis.

That said, if you’re a first-time home buyer… or even if you’ve sold you’re home and you’re moving on to a new one, my goal here is to at least suggest you do the math based on your situation. Weigh your options: Higher loan amount with lump sum amount preserved in a safe, FDIC backed interest-bearing account, OR lower loan amount with higher down payment poured directly into the house.

Is the interest rate and monthly PMI payment enough to outweigh the security of knowing exactly where your money is? Knowing exactly how much you have? Or is it still better to invest more in your home?

I’m interested to know what you think. If you find yourself doing the math, please share your comments and results!

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Real Estate Down Payment: Gone in 60 Seconds?

Consumer confidence reached an all-time low and 100,000 Americans were issued layoff notices last week, each playing a role in the mortgage market’s relative worsening. />

For the third consecutive week, mortgage rates rose and average loan fees increased, too.

Amid all of the negative economic news, however, there were two bright spots worth identifying and discussing. They show that country may be closer to economic recovery than expected.

First, the supply of “used” homes for sale fell from 11 months to 9 months nationwide. This suggests that homebuyers are re-entering the housing market in force, a signal that home prices are nearing equilibrium.

And, second, the nation’s GDP — a measurement of the country’s complete economic footprint — didn’t fall by nearly as much as what the experts had predicted. A positive surprise like this makes us wonder about what else the Doomsday Economists may be wrong.

We won’t have to wonder long.

With this week comes copious amounts of data, legislation and rhetoric to influence mortgage rates. Some of the news-bites that mortgage markets will digest this week include:

• The Personal Consumption Expenditures Index report. PCE is a preferred inflation measurement and inflation is the enemy of mortgage rates. A high reading will pressure mortgage rates up.
• Retail stores report on same-store sales.
• The Pending Home Sales report. This notes the number of “homes under contract” and is a good gauge for buyer interest and the general health of housing.
• 20% of the S&P 500 firms will report earnings.
• Congress is expected to vote on the Stimulus package.

The biggest impact on rates, however, could come on Friday with the release of January’s jobs report. Employment data is always market-mover and with the press giving so much attention to layoffs lately, expect Wall Street to be extra jittery it.

Markets expect the economy to have lost a half-million jobs last month.

(Image courtesy: Wall Street Journal Online)

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Are we Moving Further and Further from those 4.5% Mortgage Rates we’ve Been Hearing About?

After a strong start Monday and Tuesday, mortgage markets suffered alongside stock markets in the latter half of last week, leaving mortgage rates higher on the week overall.  Market losses were especially steep Friday and mortgage rates headed into the long weekend on a strong uptick.  Regardless, the reasons that mortgage rates rose last week are ancient history, in most respects.  Today, the new presidential administration begins and economic expectations reset. Mortgage bond traders are now looking at Capitol Hill and wondering what the pending stimulus package will look like, and how many dollars will it include.  This is an important time for home buyers and rate shoppers, too, because stimulus is generally believed to be harmful to mortgage markets. This is for two reasons:

1. Stimulus draws money to the stock market from the bond market, pressuring bond prices down and, therefore, mortgage rates up.
2. Stimulus requires the “printing of money” which devalues the U.S. Dollar and everything denominated in it. This includes mortgage bonds and rates respond by rising.

In other words, as the scope of the stimulus package increases, it becomes more likely that mortgage rates will rise in 2009.  Aside from Beltway Politics and commentary, there isn’t much to impact mortgage markets this week. We’ll see the latest earnings from a handful of financial firms and tech bellwethers including Google, Microsoft and IBM. And, on Thursday, we’ll be treated to some housing data from December.  But, with expectations set so terribly low for everything economic, markets will likely shrug off any data that doesn’t scream that the recession is over. Instead, be on alert to lock a rate. In a changing political environment, mortgage rates can move quickly and it’s best to be prepared.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Outsized Economic Stimulus Packages can Cause Long Term Harm to Mortgage Rates

When people first decide to buy an apartment building it is common for them to make a few easily preventable mistakes. The most common error that I see new investors make is not having what I like to refer to as the “investor tool chest”.

For example, if you wanted to build a house you would need a few things to get started. You would need first to have a blue print for the home drawn up by an architect. Second, you would need to have the proper tools to actually complete the building, You would need the nails, hammers, saws and drills to work on the raw materials. Thankfully, investing in apartment buildings doesn’t require any physical tools or skills. However, investing in apartment building does require the same kind of mental planning and in this case your “tool chest” is actually a “tool chest” of knowledge.

To Be a Successful Apartment Investor, You Must Have a Plan!

The best way to acquire these essential educational tools is to read many books and magazines on the subject. The first and most important tool that an investor can have is the ability to determine the investment value of apartment building. There is no way that an investor can be sure that he or she will be buying a cash cow or a money pit without the necessary ability to analyze the value of a building. There is an endless array of information available about debt coverage ratios, cap rates and real estate evaluation. In my opinion the first time commercial real estate investor should operate with one simple mental “tool” or presumption and that is to determine what the building is worth to him or her and to ignore almost everything else. What this means is that investor should virtually ignore what prices other similar properties have recently sold for in the area. Instead, the investor should figure out the price that will allow him or her to buy the property and make the profit and cash flow that will make it a good investment.

In order the figure out what price you should pay for an apartment building, assuming for example that you want to realize a certain return, or Cap Rate on your investment annually, simply use the following formula:

Net Operating Income
__________________ = Price You Can Pay to Realize a Desired Cap Rate
Capitalization Rate

Photo Credit: jthetzel

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Buy an Apartment Building With a Tool Chest of Knowledge