Market Decline?

Question

I am no expert in markets, finances or anything like that.. but since the stock market seems inflated.. are we going to see real estate prices drop within the next year? Specifically if the stock market drops significantly?

Cal C. · Answer

I'm not certain that the Fed will come close to getting to 2% by the end of 2016.

Here are a few reasons why.

China just cut its discount rate again.

Japan and Australia are cutting.

ECB instituted quantitative easing and even the Germans are tacitly going along with it.  Something the Germans were vehemently against previously.

The labor participation rate is at a long term low.  Yes, I know that the unemployment rate is 5.4% but the labor participation rate is more than 2% lower than what it was when the unemployment rate was at 10%.  Basically the government is trying to tell us that a lot less people are working but the unemployment rate has fallen by half?  Really?

Some European countries and the ECB have cut key interest rates to below zero.  (Despite the fact that some moron on BP told me that couldn't happen.)

Wage inflation seems a long ways away particularly given the current administration's affinity for regulations which make it harder and harder for small businesses to get going thus hindering the greatest engine for job growth.

Given the likelihood that executive action is very likely before 2017 to stop global cooling/warming/climate change/disruption, I don't see wage inflation causing much of an issue for the next two years.

Andy Mirza · Answer

@James DeRoest, Account Closed

I agree with many of your points. I agree that increased interest rates make it more difficult for buyers that need financing to buy because the maximum they can afford to buy is less. I still disagree with the statement "when interest rates go up, housing prices go down." It's not that simple and is "underthinking" it.

Let's look at some charts:

Case/Shiller Index Historical Data quoted in the NYT:

http://www.nytimes.com/imagepages/2006/08/26/weeki...

Historical Mortgage Interest Rates from Freddie Mac:

http://www.freddiemac.com/pmms/pmms30.htm

(I'm sorry I don't have anything better but this is what I got from Google in just a few minutes. It's enough to get the point across.)

If you take a quick look at the interest rates and compare them to the peaks and valleys of home prices you'll notice the following:

** Home prices went up as interest rates went up during the boom of the '70s.

** When interest rates hit their peak in 1981-1982, home prices were bottoming out after declining for the previous three years. After 1982 home prices went back up without a significant decline in interest rates. Keep in mind that we're talking about inflation adjusted dollars for this index. If you looked at nominal numbers, you'd probably be looking at a much smoother curve and you'd only see that prices were flat at worst but most likely going up.

** Rates were pretty flat in 2000-2006 yet prices went through the roof. We've all heard the various reasons why the market went up but we clearly see evidence that other factors can be far more important and have a far greater impact on prices than the interest rate alone.

Again,  if one believes that "if rates go up, prices go down," shouldn't the opposite be true? "When rates go down, prices go up?" Remember 2009-2010? Super low rates but nobody but investors buying with cash.

I invite you to look at these charts and form your own opinion instead of taking my word for it :)

Andy Mirza · Answer

Account Closed

I think that the saying, "When interest rates go up, housing goes down," is too simplistic when describing the behavior of the residential housing market. You hear that statement frequently from the talking heads on TV and I think it's perpetuating a conventional wisdom that's not necessarily true and does a disservice to the average American listening.  Given the nature of your response, I see that you're knowledgeable and experienced about the subject so let me explain a little further. I don't pretend to know everything but here are my thoughts and please correct me if I'm wrong.

First, let's just talk about residential real estate. Commercial RE (apartments, office, industrial, etc), HML are different animals and the people involved in those transactions are interested in cap rates, income/expense ratios, etc and interest rates affect their decisions differently because they are making business decisions whereas, owner-occupants for the most part are not making 100% business decisions when buying a house to live in.

And I'll be more specific to California RE because that's where I'm from and where I do business. I don't remember if Greenspan raised rates in 2000 like you mentioned but I'm pretty sure that he lowered rates in response to the tech bubble melt down in 2001-2002 and the unintended consequence was the housing bubble. You're right about lenders today not lending to someone who needed to spend half their income on a mortgage. With the current overlays of most lenders and high underwriting standards, there's no way that something like that would fly even though interest rates are "3.93%."

What were your chances of getting a 6% loan back in 2005? If you had a pulse or could fog a mirror, your chances were probably 99%.

If rates today "shot up" to 6% today, would it hurt housing? Most definitely. Would it be because of the interest rate? Maybe yes, maybe no. I think far fewer people could get an equivalent loan today than they could in 2005 and that has everything to do with the current lending environment and not the actual interest rate.

In my previous post, I mentioned that I think higher rates might not deter buyers. Owner-occupants of residential housing do not make their buying decisions in the same way that buyers of commercial property do. There's a psychological element to it. Increasing housing prices and increasing interest rates tend to get people off the fence and add to demand. As we saw in the last run-up in housing people get crazy when the market reaches euphoric levels.

In addition to interest rates, you have to look at government housing policies, the entire economic outlook, incomes, etc. I'm just saying it's not as simple as "interest rates go up, housing prices go down."

Andy Mirza · Answer

Account Closed

I don't buy into the idea that when interest rates go up that housing prices go down. An increase in interest rates definitely affects the maximum amount that people can borrow i.e. they will be able to afford less house.

Wouldn't you think that the opposite would be true? That prices would go up or demand would be up when interest rates were low? A few years ago when rates were super low, demand was weak and houses were hardly selling despite super low rates.

When rates stay very low, a lot of buyers out there feel no hurry to buy a house. When rates start to go up, more people start paying attention and start thinking about making a move before it's too late, before rates go higher. More people start buying, which causes housing prices to increase. When rates go higher, more people join in and get caught up in the idea of getting into a house before prices and/or the interest get too high and they can't afford it.

During a run up, buyers are willing to pay more of their income towards housing costs. Normally, people pay about a third of their income towards housing. Near the top of a cycle, people will pay 1/2 or more of their income to be able to afford a house.

Andrew Syrios · Answer

There definitely seems to be some of the same nonsense going on now that was going in before the first crash, albeit, not as bad. And given how far it dropped, it's not surprising that the market has rallied a lot. There's usually a big rally after a big fall. That being said, I wouldn't be surprised at all if we're in a mini-bubble that's about to pop.

Lynn McGeein · Answer

Saw this in a WSJ blog

http://blogs.wsj.com/moneybeat/2015/05/07/stock-bu...

"buybacks have been widely cited as giving fuel to the bull market in stocks, now in its sixth year. Corporations have amassed massive cash stockpiles in the years since the financial crisis, plowing much of it into shareholder friendly activities like buybacks and dividends. Cash held by S&P 500 companies stood at a record $1.43 trillion as of the end of the fourth quarter, according to FactSet."

Unlike the liquidity crisis in 2008 with almost everyone over-leveraged, corporations are now hoarding cash.   I am not an economist, but it seems safer, that corporations and people in general are overall more cautious than before.  Yes, there are still low-down owner-occupied loans, but even they are subject to stringent qualifications.  Investor loans are extremely tight, especially the 5-10.  Where before 10% down and a pulse could easily get you an investment loan, now we are looking at 25% down and so much documentation that you are mentally exhausted by closing.   Add to that the huge number of cash purchases since 2008, and the housing market, I believe, anyway, is just more solid than it was before.  As rates rise, people will be able to afford less, but I see more moderate fluctuations in the market rather than severe swings or tons of foreclosures like before because the standards have been higher for years now and those loans should be more able to weather periods of decline.

James DeRoest · Answer

I think your initial post puts too much emphasis on much smaller trends when the market changes.

However, the basic premise that prices go down when rates go up is spot on. You really don't need to over think the concept that if rates go up, people will afford less, and those that are already stretched today, will get crucified (again) when rates go up.

You are overthinking this. We did all this voodoo economics before 2007, it didn't end well.

Jay Hinrichs · Answer

Account Closed

you make of course very good points.

I struggle with this as well.. as we have new construction homes going on here in PDX.. price point 300 to 425k... with median in the market close to 300k.

and inner city PDX prices are more 450 to 750k...   I think this is market specific were we have a acute shortage of housing I think we will still sell our product.. I think what will happen is the 525k buyer of today will be looking at our 425k product.

Also whats very different about Post GFC and pre is when I sold my homes PRE I can I think count on one hand the amount of folks that put more than minimum down.. in the last 36 months We see many more conventional 20% or better down and a lot of cash sales I had not seen a cash sale for ever pre 08...

So I can see folks ponying up more cash to make the numbers work... buying down a little bit... But when you have more people than homes I think our values hold here.

Now that's of course our market.. and not the same in other areas.. Were there is no shortage of housing stock

Andy Mirza · Answer

Thanks, interesting article. It'll be interesting to see what happens in the next couple of years on that front....

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