Interest rates appear to finally be on a long and steady climb upward, and this trend may accelerate a bit in coming months. There is no doubt now that the Fed is concerned about inflation as wages creep up, and the consumer price index (CPI) follows.
While some expect home prices to move inversely with the increasing cost of money, that’s not necessarily what will happen. What WILL happen is that affordability will remain an issue, and sales volume will slow down but not collapse. There will be an impact on prices, but at the moment, it looks as though we’ll move out onto a plateau, and the price appreciation curve will flatten out more and more. Again, we don’t foresee a collapse in prices as much as the media proclaims.
All this is not a cause for alarm. What is happening is that both money markets and housing markets are moving back toward what are historically normal levels of both the cost of mortgage money and the rate of home price appreciation.
Because many markets, even those overheated bi-coastal markets, are still supply constrained, demand will remain strong and sales volume should remain healthy. But the mania we have seen in the last eighteen months should finally subside.
We have experienced a period of rapid price escalation fueled by artificially low interest rates that has no historical precedent. Previously, cycles in the housing market have run for five or six years, while in this case, the boom has continued for nearly ten years. That has never happened in the U.S. before.
So, as Alan Greenspan pointed out in his final appearance before Congress “…long periods of relative stability often engender unrealistic expectations of its permanence…” This can not only refer to the persistently low interest rates we have seen in recent years, but also to the steady upward march of home prices.
Ok, so a sea change is beginning. Why? For one thing, we have to factor in China. (We are in a global economy now, right?) Last month, the Chinese caught our money markets by surprise when they devalued their currency by 2%. Not a big deal, you might say. True, they did it to dampen the tariff drum- beating that has been going on in Washington, but we think it’s the first of more to come.
They’ve also slowed down their purchases of our treasuries. They were swimming in dollars from their export earnings, and were loaning those dollars back to us by buying our bonds. But now Asian demand for our debt securities is waning, and they want stronger yields when they do buy. The bond market is feeling it. The 10-year note closed at 4.39% on August 5th. Not long ago its yield was under 4%.
This is impacting fixed rate mortgages, which have, at this writing, moved up for five straight weeks. The 30-year fixed is now flirting with 6% (5.77% now). A few months before economists saw it reaching this level. (This is part of the reason why economics is called “the dismal science.”)
Then we have the Fed’s determination to keep tightening on short-term rates, which as we pointed out last month, is already affecting adjustable rate loans.
As Colorado financial writer and mortgage broker Lou Barnes pointed out in a column published on July 25th, the markets have already priced in the 4% year-end short term Fed rate we mentioned last month. But will they stop there? What will Greenspan’s replacement do? (The Man retires in January).
Barnes tells us to take a look at history, and what he suggests makes sense.
To summarize, when the CPI increase goes past 2.6 percent, the Fed turns on the cold water by raising the discount rate. In 2000, it got to 3.3% and the Fed overdid it by going to 6%, and sparked the recession of 2001.
In the last 12 months, according to Barnes, the CPI has increased by 2.6%. We can, therefore expect the Fed to keep going, perhaps to 4.75% and, perhaps beyond.
Now what does all this mean to us?
First of all, there is no doubt now that we are finally entering a true rising interest rate climate after years of giddily low rates and lenders shoveling money out the door to everybody. In other words, we’re finally getting back to normal. Believe it or not, that’s a good thing.
As investors, we can now look forward to some changes. This simply means that the ground on which we find opportunity may change.
As we said last month, lenders got caught up in all the excitement and started putting out some pretty nutty loans. They’re still doing that. But the underground rumbles indicate that they have seen that they’ve overshot the target in terms of risk management. They’re starting to tighten up credit standards and payment/income ratios again (phew).
The result? We’ll still be helping people out of no-win situations with our win-win proposals, but in the future, we may find ourselves rescuing a few lenders along with our homeowners.
Right now, while markets are still hot (or at least warm) lenders don’t need us. They are not swamped with real estate owned (REO). They fix up what they have to take back, and list the properties for full value with Realtors. They won’t sell for a discount, because they don’t have to!
But, with all the zero equity, convertible interest only loans, and option ARMS out there, as the market cools and levels out or declines modestly in some places, in 3-7 years more people will find themselves with no place to go when reality comes knocking.
In the cases where we find no equity, there’s not much we can do for the homeowner, but we can do a lot for the lender trying to get those non performing assets with liability exposure off his books.
We’ve been there and done that in the 90’s. When that time comes again we’ll be here to tell you how to make deals with bankers. (They are different than owners in default.)
In the meantime, we are in transition. There are still plenty of people out there that need our help who have equity. We just want to give you a heads up times may be changing and you need to change with the times!
That’s part of what we mean when we say that you can make money by investing in foreclosures in any real estate market. We’ve been doing it for over twenty years, and no matter what happens, we’ll show you how to continue to profit (and never be an unemployed investor)!
