quick one on the questions, more detail needed for specifics.. so here goes:
1) further reduce the pool of available buyers Correct, as rates go up, fewer people are able to make the monthly. It increases price, reducing demand(realizable demand, not wishful demand) at that price point against a near constant supply(actually increasing supply in SD’s case w/ unsold inventory, REOs etc) This will drive the price down. In general, with liquid markets, price will move in opposite direction to interest rates.. much like a bond will. A house is a yielding asset. The yield is the value of the rent it displaces minus any appreciation in value over the time period – allowing for any mortgage interest tax breaks and property taxes, maintenance etc… your mileage may vary.
2) more fairly value the cost of money Fairly to whom? This ends up being a relative question. Higher interest rates mean that the time-cost of money is lower as well as the time yield of money is lower. Since houses are a long term asset paid with by a long term loan, a purchaser has to be aware of what the historical rates have been, whether their loan will reset, etc). If rates are low and fixed, they will be paying with ‘cheaper’ money.. allowing them to pay more for the asset (while having the same monthly cost). It also means that a down payment has a lesser effect on reducing the monthly cost.. and therefore values the down payment less.
3) it seems intuitive that sellers would have to price the cost of financing into their asking prices No they don’t have to.. it is their choice at which to offer the property at. There are several variables. Are they sellers carrying a large loan balance on the property, such that if they sell at the market price.. they will be selling at below outstanding liens on the property? If so, they need to get approval for a short-sale from the lenders. Sometimes sellers are shocked that the 15% yearly suddenly ended and that suddenly there is no track left for the train. Many will probably end up chasing the market down instead of taking the hit up front and pricing at the market.
Obviously there are a lot of other side effects from high mortgage rates, such as an economic downturn, which might outweigh the above benefits, but that’s not really what I’m considering.
This is actually a yes-no thing. A market down-turn and the degree of a downturn depends upon how many people used their houses as ATMs, how many are on Adjustables, what their LTV is, how many investment houses/banks have buried their exposure to CDOs/MBSs in SIVs(Structure Investment Vehicles). It is actually quite complicated, virtually guaranteeing that this market is going to be in turmoil. Watch consumer discretionary first, followed by non-discretionary.
