Comment on Rich’s Article Credit Where Credit is Due

[nhamlin]

Responding to Rich Toscano’s Article about credit where credit is due. Rich knows that I agree with him about the craziness of the SD real estate market and his general approach.

I strongly challenge his assertion that low interest rates do not or at least should not cause real estate prices to rise.

I am a professional investor with some very old fashioned ideas. One of them is that the purpose of income property is to produce income!

I became active in investment real estate in 1977 about the time that interest rates went from the low 8% range to about 10%.

As tight fisted as I am I will gladly pay more for property in a 6-7% environment than in a 10% invironment.

If you live in a small town in Indiana surrounded by corn fields, resale prices are pretty much limited by the cost of new construction.

A would be buyer can always find a farmer who will sell sell an acre of land for virtually nothing compared to the cost of constructing a home.

In Southern California, substantial price increases often have little impact on inventory. Consequently, lower interest rates tend to push up prices rather than increasing inventory.

[powayseller]

There is usually an inverse relationship between home price and interest rates. In the late 1970’s as interest rates increased from 9 to 11%, median home price/per capita income increased from a little over 8 to 10. Over the next 2 years, as interest rates increased to over 16%, home prices decreased to a ratio of 9. During the years 1977 – 2005, there was an inverse relationship between interest rates and price/income for 18 out of 29 years (per my visual look at the chart accompanying Rich’s article).

So although low interest rates led to increasing home prices during this bubble, it does not always do so. This bubble was helped by loose lending more than anything. Once lenders eliminated the down payment requirement, anyone with a pulse could buy a house.

Although people may pay more for a house when interest rates are low, the point of the article is that this in no way makes the home more valuable. If it did, now that interest rates have gone from 5% to 7%, an increase of almost 50%, home values should have fallen a great deal. They have not. Why are people not willing to pay 50% less for that same house, now that their payments are 50% more? So much for the direct link between interest rates and home prices.

[Blissful Ignoramus]

It’s the simple distinction between isolated cause and effect (lower rates lead Norm to buy a property at a higher price) and a general cause and effect (lower rates lead to increases in median prices over a large geographic area).

We also have to keep in mind that rates go up and down for a reason. As a matter of monetary policy, they’re raised to fight inflation, and one of the prices going up in an inflationary environment might be real estate. In those cases, increased interest rates may only put a drag on increases, and not actually be able to drive them down.

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