Interest Rates and House Prices

[AmenhotepIII]

Hello,

Been following the housing market in San Diego since 2003-ish, saw the boom and bust and there’s something that I’m trying to extrapolate out how the current really low interest rates. I believe at least a basic relationship between interest rates and housing prices is that when rates go up that prices tend to go down (and visa-versa), as the majority of people buy houses with 80% borrowed money. So with prices on average pretty low and interest seemingly now setup for a mid-2013 increase (referring to Fed’s statement).

So my question which may be obvious is, as house prices drag along the bottom what will happen when the housing rate increases to say 6 to 7%? I see two things as possible, both could be 100% wrong though. The banks raise the down payment requirement so buyers will have to put more down to somewhat offset the rates? Or, SD house prices drift down to compensate?

Just interested in opinions, as in the 1990’s boom/bust I seem to remember the interest rates had room to fall along with prices.

[Coronita]

Interests rates probably will be low for a non-insignificant amount of time imho.

I just closed on my refinance 15 year 3.375 no points/fees.
And looking around, I’m seeing 15 year 3.1ish these days…
Go figure…

[davelj]

The issue for housing prices vis-a-vis interest rates is the degree to which rents increase along with interest rates (which eventually reflect the general level of price inflation). If rates rise meaningfully more than rents then housing prices will fall. If rents rise more or less as much as interest rates then housing prices will be largely unaffected even if rates rise (see the 70s and early-80s for an example of this).

If the value (V) of a perpetual stream of cashflows (CF) is denoted by:

V=CF/(R-G)

where R is the interest rate and G is the growth in the cash flows, you can see that if G (re: rents) is increasing at the same rate as R (rates)… the denominator stays the same and the value is unchanged even as rates rise.

So, the issue of the impact of higher interest rates on housing prices must be discussed in the context of the degree to which rents follow the general level of inflation (the latter will drive interest rates).

[SD Realtor]

Dave I think it could be argued that the relationship between housing prices and salaries for a given region would alter the formula you put forth. For the most part I would agree with that formula for most of the country however I think it doesn’t hold up as well for areas with distorted prices. For proportional price hikes the buyers pool shrinks more rapidly in the distorted regions especially as lending standards tighten up.

[(former)FormerSanDiegan]

davelj makes some excellent points, as to the other factors involved (namely rents).

People tend to look at how interest rates relate to payments. They correctly see that an increase in rates lowers the amount of property they might qualify for. However, people often make the mistake of extraolating this to the macroeconomy.

The mistake is assume that other factors remain constant (rent, income, inflation, etc).
Interest rates do not move in a vacuum.

If prices were inversely proportional to interest rates, we should have seen significant increases in prices as rates fell from about 6% to near 3% over the past 6 years.

In fact, history tells us that interest rates and housing prices over long-term periods (e.g. 5 year periods) tend to move in the same direction.

The lay person might ask, “How can this happen if the amount of the loan I can afford decreases when rates go up ?” The answer is that over the long run rates tend to move up with inflation and down with disinflation (or outright deflation). Rates are low now because the economy is sluggish, joblessness is high. Rates historically increase when either the economy is on the upswing or inflation is present. In both cases (historically) home prices tend to move up.

Look at what prices did in the late 1960’s to the early 1980s as interest rates moved from 5 or 6 % to the teens.

An inverse relationship of home prices to interest rates is a fallacy.

[(former)FormerSanDiegan]

Here is a re-post of something I wrote back in February with some historical info …

If rates changed instantaneously by 1% and no other factors in the economy changed, then the price would be inversely related to rate.

However, rate changes never happen in a vaccum. Rates respond to underlying economics, so changes in home prices rarely respond as you suggest.

Example #1: From 2006 to 2010, 30-yr mortgage rates declined from around 6.5% to less than 5%.
Did prices increase by 10%+ during that period ? Hell No. Prices declined at the steepest rates since the depression.

Example #2: In late 2002 30-yr mortgage interest rates were at 6%. BY mid 2006 they were 6.5%.
Were home prices flat during that period ? No. They were quite bubblicious.

Example #3: From 1990 to 1995 rates dropped from 10% + to about 7.5%. Did prices rise during this period ? Not really.
This period current decline) in home prices in post-war California.

Example #4: In 1972, 30-yr mortgage rates were about 7.4%. By 1989, rates were above 10%. What did home prices do doing this period ?
Hint: they did not decline.

The simple point is that it’s not that simple. Rates do not change in a vacuum. As a thought experiment prices are inversely proportional to rates, but in reality, it is not neccessarily so.

[bearishgurl]

[quote=SD Realtor][quote=davelj]The issue for housing prices vis-a-vis interest rates is the degree to which rents increase along with interest rates (which eventually reflect the general level of price inflation). If rates rise meaningfully more than rents then housing prices will fall. If rents rise more or less as much as interest rates then housing prices will be largely unaffected even if rates rise (see the 70s and early-80s for an example of this).

If the value (V) of a perpetual stream of cashflows (CF) is denoted by:

V=CF/(R-G)

where R is the interest rate and G is the growth in the cash flows, you can see that if G (re: rents) is increasing at the same rate as R (rates)… the denominator stays the same and the value is unchanged even as rates rise.

So, the issue of the impact of higher interest rates on housing prices must be discussed in the context of the degree to which rents follow the general level of inflation (the latter will drive interest rates).[/quote]Dave I think it could be argued that the relationship between housing prices and salaries for a given region would alter the formula you put forth. For the most part I would agree with that formula for most of the country however I think it doesn’t hold up as well for areas with distorted prices. For proportional price hikes the buyers pool shrinks more rapidly in the distorted regions especially as lending standards tighten up.[/quote]

I don’t quite understand the formula dave proposed here but I understand what he was trying to say re: rent levels proportionate to interest rate levels with regard to positive/negative cash flows for a landlord. (Correct me if I don’t have this right, dave).

And I also understand what SDR is saying here, but don’t think it rings true for SD County. I believe low and moderate income tenants or potential buyers of same have ACCEPTED the “sunshine tax” for housing in SD County for many years as a prerequisite to living here and will continue to do so. Many will simply use more incomes (thus put more persons on the lease or title) to rent or buy a property. I believe this is due to “coastal” SD County’s near-perfect weather 95% of the time and its proximity to Mexico and LAX (Asian immigrants) and also shortish driving distances to desert and mountain resorts in AZ and RIV and SB Counties.

EVERYONE here has the option of voluntarily moving to the nation’s midsection (for example), where housing is cheaper, often better built and there are more jobs. But how many actually do? Life is *very* different there than here. There is price to pay for everything. SD County’s desirability isn’t going away, prices here are a function of supply and demand (just like anywhere else). A legal (or even illegal – with cash) immigrant from south of the border can buy property here and STILL live in close proximity to their families in Baja Norte, MX and even <= a day's drive to Baja Sur, MX and the interior state of Sonora along the Sea of Cortez. Besides Imperial County (often hot & dusty), where ELSE is this possible?? If your answer is Brownsville, TX, that (gulf) region and the MX state of Tamaulipas don't hold a candle to the Pacific Ocean and Baja, CA. They're not even in the same league. I believe the VALUES here are different for the middle-class on down to low-moderate income buyers/tenants here. Many persons who reside in SD County who are not well-established here (i.e. have little to no assets) and sometimes no familial ties are (consciously or unconsciously) *willing* to give up a certain amount of discretionary income to remain here (i.e. keep their rent or mtg/taxes paid). I have come to the conclusion that longtime and native residents of the nation's midsection with comparable incomes to low/moderate-income San Diegans are established near their families and used to consuming or saving more and thus are NOT willing to relocate to a coastal locale with prices similar to SD County's because they have NO IDEA what they are "missing" by not living here, nor do they care. Different strokes for different folks. I believe that even if all recent SD "transplants" become disgusted with what they can buy/rent here and load up their moving vans to places like Tulsa, OK, where they can buy a sprawling, manicured 2700+ sf mid-century brick ranch on a "leafy" 1/2+ AC lot in the middle of town for $250-$275K, SD's RE market will not miss a beat. These former residents' SD homes will be promptly rented/sold to longtime San Diegans (or their children, often with parents' help), SF bay area transplants or immigrants from everywhere in the world (both longtime and recent residents). Believe it or not, areas such as Paradise Hills, Valencia Park, Lomita Village and Nestor (all City of SD) are VERY desirable to particular subsets of buyers and tenants both culturally and location-wise. I don't think we are currently in a RE "bull" market by any stretch of the imagination, but this is just the way I view the region, based upon my own experiences. Looking thru the eyes of many potential first-time buyers, I just don't see the issue of SD's "desirability" and "buyer willingness to pay" as a pure numbers game, as many Piggs seem to. In short, I don't think any (real or perceived) "price distortion" has or will ever affect the desirability of the SD region. Where there is a will, there is a way to rent/purchase a place to live in SD. Persons who want to buy bad enough can will find a way, even under more stringent mortgage underwriting guidelines (as they did "pre-millenium bubble"). Nothing has changed in this regard.

[davelj]

[quote=SD Realtor]Dave I think it could be argued that the relationship between housing prices and salaries for a given region would alter the formula you put forth. For the most part I would agree with that formula for most of the country however I think it doesn’t hold up as well for areas with distorted prices. For proportional price hikes the buyers pool shrinks more rapidly in the distorted regions especially as lending standards tighten up.[/quote]

All of that may be true – I don’t disagree. There will always be regional variations for various reasons. I was just pointing out how the math works for the *average* home (think St. Louis). Interest rates don’t move in a vacuum – they are highly correlated with overall price inflation movements over the long term, and inflation has in the past always been highly correlated with changes in overall rents… but that doesn’t mean that this relationship will necessarily hold when and if rates start rising again…

[fun4vnay2]

I don’t really see a lot of value in staying in SanDiego.
I am here just because I have a well paying job.

I always tell my friends: You are well off in low expense areas like TX, Carolinas.., don’t come to CA

Look at the amount of people( eg in Piggington ) discussing housing here because of the high cost.

You would find people in other parts of the country engaged in some better activities.

[sdrealtor]

Exactly! People in other parts of the country truly get to enjoy playing golf all year, driving to the mountains for great skiing, world class surfing, mountain biking, hiking, weekends in vegas/palm desert/napa etc. We have none of that here to enjoy;)

[temeculaguy]

[quote=FormerSanDiegan]Here is a re-post of something I wrote back in February with some historical info …

If rates changed instantaneously by 1% and no other factors in the economy changed, then the price would be inversely related to rate.

However, rate changes never happen in a vaccum. Rates respond to underlying economics, so changes in home prices rarely respond as you suggest.

Example #1: From 2006 to 2010, 30-yr mortgage rates declined from around 6.5% to less than 5%.
Did prices increase by 10%+ during that period ? Hell No. Prices declined at the steepest rates since the depression.

Example #2: In late 2002 30-yr mortgage interest rates were at 6%. BY mid 2006 they were 6.5%.
Were home prices flat during that period ? No. They were quite bubblicious.

Example #3: From 1990 to 1995 rates dropped from 10% + to about 7.5%. Did prices rise during this period ? Not really.
This period current decline) in home prices in post-war California.

Example #4: In 1972, 30-yr mortgage rates were about 7.4%. By 1989, rates were above 10%. What did home prices do doing this period ?
Hint: they did not decline.

The simple point is that it’s not that simple. Rates do not change in a vacuum. As a thought experiment prices are inversely proportional to rates, but in reality, it is not neccessarily so.[/quote]

This is so well written and easily digested that I am going to save it for the next time a friend asks me this question. There are some other great posts about why this happens, but this one explains in laymans terms that history does not support the logical theory that prices are affected by interest rates.

At cocktail parties, when asked this question, the audience usually loses interest at about the 30 minute mark of my explanation (which happens with most other topics too). If I can just memorize this post, I’ll save oodles of time.

[fun4vnay2]

[quote=sdrealtor]Exactly! People in other parts of the country truly get to enjoy playing golf all year, driving to the mountains for great skiing, world class surfing, mountain biking, hiking, weekends in vegas/palm desert/napa etc. We have none of that here to enjoy;)[/quote]

I get your sarcasm:-)
But reality is: People here work to pay off mortgage not to live/enjoy making double income family a necessity

[sdrealtor]

[quote=dd123][quote=sdrealtor]Exactly! People in other parts of the country truly get to enjoy playing golf all year, driving to the mountains for great skiing, world class surfing, mountain biking, hiking, weekends in vegas/palm desert/napa etc. We have none of that here to enjoy;)[/quote]

I get your sarcasm:-)
But reality is: People here work to pay off mortgage not to live/enjoy making double income family a necessity[/quote]

That is your reality not everyone’s here. You paint a broad brush….too broad.

Life is about trade offs. Texas has lousy weather, much higher real estate taxes, an under current of prejudice (no just racial but against them damn yankees) and limited access to high quality recreational pursuits. Carolina has much of that and other issues. I have lived other less expensive places and am willing to make the trade offs to live here. If you dont value what you get here, its probably not the right place for you and there are other places you might enjoy more. No wrongs or rights…just different strokes for different folks.

[AmenhotepIII]

I concur as well, thanks to all who submitted their responses, where else can you receive such a well thought out answers, opinions, experiences and for free!

In short, the answers have only confirmed my belief that SD prices are bouncing along the bottom and will probably rise overall from here on out. Now I just have to decide if I want to move back to SD, I was a transplant there from here (Philadelphia) and I moved out partly in disgust in 2010 and partly for a job I thought would be great for my career. Things didn’t work out that way so I’m trying to decide if I want to move back or stay here. Guess I’m kinda anti-proof of BearishGirl’s post. 🙂

[bearishgurl]

[quote=dd123] . . . People here work to pay off mortgage not to live/enjoy making double income family a necessity[/quote]

dd123, a couple of things come to mind here . . .

If the above scenario IS your reality, WHY is that? Are you a “bubble-era” purchaser? Have you taken out too large of a mortgage and/or put too little down?? My P&I is currently about $1200 mo for a med-large 4 bdrm SFR. I can’t even rent a 2 bdrm apt for that in my area (or a 1 bdrm *newer* unit).

In my mind, it’s very simple. If you are living above your means or you need every cent both owner-spouses can earn in order to live month to month, you probably purchased or rented too-expensive of a property and/or a property too highly taxed (or saddled with too high of fees), barring any other consumer-debt issues.

For a middle to lower income couple or family to live comfortably here, they will invariably have to make tradeoffs …. usually in housing choices. If they are unwilling to do that, then they will feel a financial pinch every month until such time as they decide to reset their priorities or leave SD County for a cheaper locale. The only other solution is to find ways to make more money. Often, just $600-$800 more net per month can make the difference between staying here and living more “comfortably” versus leaving.

Another thing is, why would a “recent transplant” of, say, the last 10 years expect to be a one-earner household and also be able to select the housing of their choice in the area of their choice in a place such as SD County? This is not the 1950’s. Why does this expectation even exist?? And why would you think that both spouses who have signed a mortgage note together in “TX or the Carolinas” wouldn’t each work FT?? I can assure you that many, MANY dual-income families exist in those states.

This is why I have stated here before that incoming domestic buyers whose HH annual incomes are under $150K and have little set aside for a downpayment must be carefully screened and make preliminary trip(s) here BEFORE deciding to accept employment here. More often than not, their housing expectations must be drilled down far below what they are “accustomed to” or have previously “felt comfortable” living in. If this cannot be accomplished successfully, an agent/broker will just end up wasting theirs (and the potential buyer’s) time.

Not trying to “trump up” the value of living in SD County, here, because it is entirely subjective. Just trying to be REAL … face REALITY in the HERE and NOW….Remember, it’s a free country :=]

[end of rant]

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