Last week, I reviewed the effects of interest rates on home affordability. This week, we’ll look a bit more closely at the market factors that influence rates. After a decade of stability when mortgage rates remained relatively low, we are now faced with rising rates and far less predictability.
Economic markets don’t respond well to uncertainty, and we have had both domestic and global events that make it almost impossible to predict where things are going. We’ve had a pandemic that keeps resurging. Then our government responded with stimulus checks that slowed people’s desire to go back to work, throwing off the job market and disrupting the supply chain. We’ve had a war in Ukraine, where a feisty underdog is giving Russia a much tougher fight than anyone predicted, which is affecting the world’s natural gas supply. And politics have become so crazy that Liz Cheney has been voted out of the Wyoming Republican Party.
So, it’s no wonder that mortgage rates have been bouncing around. Unfortunately, these rate changes have a significant impact on the real estate market. When rates go up, people look for someone to blame, but rates depend on a whole host of interrelated factors. It would be great if we could just identify the rate-raising culprit and hope that, with a good tongue-lashing, that person or agency could fix rates, but that’s not how it works.
Homebuyers blame Realtors. Realtors look to lenders. Lenders depend on bank rates set by the Federal Reserve. The Fed pays attention to the markets and tries to predict people’s assumptions about how global events will affect spending behavior.
When you hear that the Fed is increasing interest rates, they aren’t talking about rates on home loans. However, when the Fed increases interest rates on what banks pay for short-term borrowing, those rates influence mortgage rates. Mortgage lenders set rates based on a formula that attempts to calculate a specific profit margin based on assumptions about inflation.
When the Fed raises rates, it’s usually to cool down the economy—to slow inflation. So, sometimes when the Fed raises rates, long-term interest rates go down because people believe the Fed’s actions today will keep inflation in check in the future. That’s what we saw in July. But then more economic news comes along, and people worry the Fed isn’t doing enough to reduce long-term inflation, so long-term rates go back up. This whole thing is subjective and based on assumptions.
At this point, no one knows where the market is going. Notwithstanding political rhetoric, I believe we are currently in a recession. The question is: will we have inflation, too? Until there’s a clear direction, we can expect volatility and I believe the long-term trend will be that mortgage rates continue to climb.
So, should you invest in real estate today? Well, if the past is any predictor of the future, the answer is yes. During the last 50 years, real estate values have shown a fairly predictable upward trend, outpacing inflation during that time. Most folks bought residential real estate with financing and the after-tax cost of interest was below inflation, so they got a significantly better-than-inflation-rate return. In addition to the financial benefits of home ownership over time, homeowners have been able to use their property to create a safe, comfortable shelter for themselves and their family.
In summary, real estate values over the long haul tend to outpace inflation and have been a primary driver of American wealth. I expect that to continue in the future. Here’s the caveat: only purchase real estate if you are happy with its value today. Do not buy property with the hopes that its value will increase during the first five years you own it.
If you have questions about property management or real estate, please contact me at firstname.lastname@example.org or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.