"negative rates distort everything" warren buffet. how about RE?
Flipper/Rehabber · Las Vegas, NV · Member since 2016 · 174 posts · 251 votes
The gravitational pull of interest rates according to Warren Buffett. How does this affect housing prices? must watch video for real estate investors.
@George Gammon , @Gloria Mirza, and @Nick L., great commentary.
With all this discussion of wages, home prices, interest rates, and qualification, I have to refer back to one of my favorite pieces of data that I haven't been updating lately: The Housing Affordability Index!
Here's some good historical HAI data I got together and analyzed mid-last year. I'll update it in not too long..
Scroll down a bit and look at how interest rates impact home price qualification. A lot of support came from decreased rates.
HAI from November: (courtesy of Paragon's Patrick Carlisle's work, with link:
http://www.paragon-re.com/Housing_Affordability_and_Market_Corrections )
INTEREST RATES AND RE CYCLES
In regards to George and Gloria's comments regarding the direction of interest rates and RE prices, I think we really need to differentiate the short term from the long term, and what is going on in the background. In the short term, increases in rates can cause all kinds of counterintuitive behavior (buyers buying more at higher prices expecting even higher rates). When rates are increasing over a cycle, it's usually because employment and lending conditions are improving, optimism improving, more cash on hand, oftentimes more than offsetting higher rates.
What I think we can say with a high level of certainty, is that in any given economic backdrop, lower rates would very likely cause higher prices, and higher rates would very likely cause otherwise lower prices. Imagine if the 30yr fixed mortgage rate was only 2.0% instead of 5.5-6.5% during the peak of the last market, with everything else (optimism, super loose lending, etc) the same (ceteris paribus as they say in econ...) My god!! Things would have almost certainly gone crazier. Conversely, imagine if, under the same circumstances, rates were 12%. Would things have been different? I have to say almost certainly, at least one home would have sold for less! lol
Inflation, Deflation, Fed Balance Sheet, Yield Curve, Graphs from prior conversation..
https://www.biggerpockets.com/forums/311/topics/28...
@J. Martinhousing chart is from case schiller, I think that's where I got the 10 year chart too? You're absolutely correct real home prices and nominal interest rates. Here's a chart of real rates...same take aways, but fed funds seems to have some correlation?
One thing I was thinking about that no one seems to discuss is the deflationary pressure lower interest rates could cause. Not saying they'd cause deflation but could produce downward pressure? Here's my hypothesis...Fed lowers interest rates which reduces corporate/biz borrowing cost. That reduces total cost of doing biz. Wouldn't a rational response be to lower prices to try to increase market share? If I had lower nut every month the first thing I'd do is lower prices to try to undercut my competitors. Everybody has lowering borrowing costs, so everyone starts to undercut. Lower and lower prices. Deflation as a result of lower interest rates...
Again, just thinking out loud.
George
Actually lower interest rates cause increased inflation and are the primary tool the fed uses to control rates. I.e. when inflation is high the fed will raise interest rates and when inflation is too low they will lower interest rates. Yes as you mentioned corporations will benefit from lower rates and try to increase market share, but they are less influenced by this since their cost of borrowing is less than that of a consumer. Another point is that producers tend to already have their products at a pretty low profit margin depending on the business they are in, there isn't much room for them to lower rates. Consumers on the other hand spend more when they can borrow at a cheaper rate. This is the theory that the Fed operates on and is a given as far as economic theory goes.
Speaking of inflation, everybody is afraid of it but when it comes to inflation, I think it would help a lot of people. Imagine having loans for 4% on real property with an inflation rate of 5, 6, or 10%. In real terms your actually getting paid to borrow the money. At first it would be a shock to home prices as people have less purchasing power due to high interest rates/inflation, but eventually the market would stabilize and home prices would keep up with high inflation, all while you're only paying 4% for the borrowed funds.
Absolutely right ... in fact, speaking of WB, he has also said that a 30 year fixed mortgage on high quality real estate is a fantastic way to short the dollar (bet on inflation) ... I seem to recall that he may have even used the term "no brainer" on that one. The flip side of that coin, though, is that if there is deflation, then you just borrowed cheap dollars and have to pay it back with progressively more expensive dollars, all while rents and the value of the RE that secures the loan also goes down in value ... if you are over leveraged and/or not hedged with an equal cash position as the OP wisely suggests, in that situation you could find yourself in the house of pain. To be fair, I think deflation would be temporary (it better be, or else invest in guns & ammo) and is a bit of a "black swan" event, but it is possible and I think more probable today than people are tending to give it credit for (my opinion and gut feel).
I agree with the inflation vs. fixed rate mortgages, which is why I've focused on them in the last downturn. However, I somewhat disagree that we will all end up having to pay the progressively more expensive dollars under deflation. (At least nor for long!) Huh? With every 30yr fixed rate mortgage comes an embedded option: the option to prepay the principal balance with cash, refinance, etc. into another loan. On conventional loans, they can't even charge a prepayment penalty for it! Even if rates do not go down, you could refinance to a variable rate, which is typically 75-150bp less (we'll see in the future). Or with deflation, I think most would expect low or lower interest rates.. This is assuming qualification, equity, lending. But probably not the craziest idea. So another option to refinance down..
So I see the 30yr fixed rate mortgage as an insurance policy. If you are a well-qualified borrower, you should have good odds of qualifying for something else if you don't like a potentially longer-term deflationary environment.
Some bigger fish like @Account Closedhave already prepared for a longer-term low-rate environment by taking advantage of low variable rates for a while now, and has been pocketing the difference. I gotta say, he has been right so far!! If I would have had one of those variable-rate 30yr am's I think you were recently talking about, I might have considered it! I think he and I probably agree on the general idea of the 30yr fixed rate as insurance since you don't have to stay in it forever. But unlike me, he doesn't think the cost of the insurance is anywhere near worth it! I think I'm drifting more and more into his camp.
I guess I shouldn't be too disappointed for each year my insurance policy does not "pay me out." But it does make me think about the cost of the insurance!! ;)
Speaking of insurance, Warren Buffet:
"Be greedy when other are fearful, and fearful when others are greedy."
While some people are talking about being cautious, I think their actions are saying otherwise, at least in Bay Area residential and commercial real estate (SF office.. wow! $6, $7/sq ft/mo rents for prime & rising.. ) Residential rents up 40-50%+ in the core bay all over. Prices riding fantastic appreciation. Overbidding like crazy (even considering intentionally low list prices). Many multiple offers w/ no contingencies or appraisals needed, and miniscule days on market. Actions say that others are being greedy, IMHO.
J.
1. Good point. It all depends on the rate of deflation. If it out paces the interest rate drops you've still got positive real rates. How far below the zero lower bound can the fed go before people start trying to withdraw all the cash that the banks don't have? And we wonder why Larry Summers wants to ban 100 dollar bills...;)
2. I'm sure Minh is a lot smarter than I am but there's a few things that concern me (referring to the thread about refi/ballon payments). And when I say concern, I mean frighten me like an 8 year old watching one of the SAW movies. lol ;) I'm sure if you read his post you know what I mean.
My point is just because you make money on an investment or because of a business decision it doesn't mean it was a good investment or decision. A lot of people made money owning dot com stocks from 98-99 did that make it a good investment?
I'm sure this will sound crazy but I'd rather lose money making a good decision than make money on a bad decision. Why? Because I know over the long term, with proper money management, I'll win.
I was an entrepreneur for 15 years and there was one thing I did that made all the difference in the world. I learned to play blackjack. In 2004 I read Ed Thorpe's "Beat the Dealer" and it totally changed the way I conducted business. I went from making 6 figures to 7 figures very quickly because I took the principles of black jack and incorporated them obsessively in business. The main principles being A. don't measure success or failure based on making money, base it on making the mathematically correct decision B. know the numbers and probabilities, there's no such thing as certainty and C. systematically structure money management to never go bust.
Speaking of WB I'd encourage you to think of one of his quotes when considering emulating any investment strategy that's currently hot..."never risk what you need for something you don't need"
My point is just because you make money on an investment or because of a business decision it doesn't mean it was a good investment or decision. A lot of people made money owning dot com stocks from 98-99 did that make it a good investment?
I'm sure this will sound crazy but I'd rather lose money making a good decision than make money on a bad decision. Why? Because I know over the long term, with proper money management, I'll win.
I was an entrepreneur for 15 years and there was one thing I did that made all the difference in the world. I learned to play blackjack. In 2004 I read Ed Thorpe's "Beat the Dealer" and it totally changed the way I conducted business. I went from making 6 figures to 7 figures very quickly because I took the principles of black jack and incorporated them obsessively in business. The main principles being A. don't measure success or failure based on making money, base it on making the mathematically correct decision B. know the numbers and probabilities, there's no such thing as certainty and C. systematically structure money management to never go bust.
A bit off topic here, but I gotta say this is so right on IMO. This to me is one of the major differences in thinking between a professional investor/entrepreneur and a newbie (not knockin' noobs, we were all there once). I actually learned about expected value in my past professional life as a control systems engineer designing Extended Kalman Filters (you can google it if you like), not blackjack ... 2 vastly different paths that lead to the same exact conclusion :). Engineer your investments to have a positive expected value upside and a downside that you can reasonably mitigate, insure against, hedge, and/or actively avoid.