patrick.net

exfatguy says

But if everyone is paying all-cash, which it seems so in the Bay Area, interest rates don't really matter anymore, do they?

Sure it does. If higher interest rates push down absolute prices then cash buyers have to part with less cash in order to acquire a house. Cash buyers, of all people, should be the ones most interested in seeing interest rates rise.

exfatguy says

But if everyone is paying all-cash, which it seems so in the Bay Area, interest rates don't really matter anymore, do they?

In the SFBA, yes cash is driving things to a very large extent. WELL qualified conventional buyers have been able to out-bid cash buyers by removing the appraisal and loan contingencies and paying the difference between the offer and (lower) appraisal. This will probably knock out some of those conventional buyers, allowing investors / cash people to enter more winning bids. That might slow price increases a little since there will be a little less competition.

At the same time, it might not make much of a difference. Inventories are so low that probably only the top 20% of interested buyers actually have the financial means to buy right now. A rate move like this is basically immaterial to this group. Say you borrow the conforming limit in SCC of $625k. A rate move from 3.5% to 4.125% is a monthly difference of $222. The top 20% of earners in the SFBA couldn't care less about that.

Months ago, an agent told me that he thought that a rate jump would spur a big increase in inventories as sellers think, "well, better sell now while people can still afford to pay!" I guess we'll see, but I wouldn't bank on it.

Call it Crazy says

What if previous cash buyers want to sell if absolute prices drop with higher interest rates? They don't have a mortgage to default on and walk away... They become "stuck" too....

It should be like any other investment. Sometimes you win, sometimes you lose. The benefit of cash buyers is that their losses cannot be passed along to taxpayers. Even if they have to take a hit to their previous cash purchase, they will make it up when they buy the next house. Their house wouldn't be the only one to have lost value. Yes, they will have made less money on the sale... but they, too, will pay less for the next purchase.

Back when I closed in May 2011, the rates were 5%. I would not call the recent jump a "catastrophy." If anything, it would be great if rates went up across the board, whether it be savings accts, CDs, mortgages, multisector bonds and high yield bonds. That way there will be less distortions and a proper accounting/payoff for risk differential and everyone can "get theirs."

strangely as has been posted elsewhere in this forum, as rates increase prices will go up (not down) since a certain segment of sideliners will buy now to lock in the best rate they can.

Also rising rates infer an improving economy. (take that with a sizable grain of salt.)

curious2 says

I wonder if Bubbles Ben might see the news and type up more $$$ to drive yields back down.

That's a distinct possibility. Unfortunately, fundamental measures must now include the behavior of the FED when judging market direction, and that really sucks.

curious2 says

I wonder if Bubbles Ben might see the news and type up more $$$ to drive yields back down.

Bubbles Ben's incentive to drive rates lower was not just for the sake of driving rates lower. It was to make money cheap so that it could "grease the wheels of the economy." At least that was the stated goal if you believe it. So, if rates are rising but economic indicators are reporting improvements in consumer spending and employment, the Fed likely won't do anything to drive rates back down. As Bubble has said, if employment and inflation targets are met, he will start curtailing QE measures.

What about any of these machinations will be increasing the common worker's ability to pay higher and higher rent? You ARE assuming rents can continue to increase, yes?

Or are you all admitting that the market is now purely speculative investment territory? In that case, the cycle is very short indeed. The worm can turn virtually overnight. Real estate can be a highly illiquid investment that could lose its appeal to these all cash investors very quickly.

I wish there was a way to find out how many of these all cash buyers are hedgies and other big investors that are leveraged up to the hilt.

"The worm can turn virtually overnight." -- Is this a Chinese Proverb?

Rates are only one variable, albeit an important one, in the pricing equation. We are nearing the peak of this investor driven bear market rally in real estate. Why do I say this? Simple - math matters.

Demand Side

Primary Residents: Once rates bottom, and I hope they have, then monthly payments can only grow proportionately to wage growth (same as rents). We have been experiencing hurricane force tail winds thanks to the Fed since 2008. If rates stop falling then we are stuck in the doldrums, and when rates rise we will have headwinds. If rates rise faster than wages can compensate, then we have a fundamental shock to the system that will drive prices down. The SFR homeowner is the heart of the market. While investors may drive prices higher, they have to sell to someone. That someone is the rate-sensitive homeowner.

Investors: Buying for investment makes sense while prices are rising and rates are falling. From a rental perspective, this makes sense if cash-flow is positive such that a sufficient return is made on the investment relative to other present alternatives. With so many new rentals coming online, rents are bound to be impacted. Vacancies are also an issue as they can effectively take all the profit if only 10% of the rentals are vacant. Keeping one place rented is hard, much less the thousands that the hedge funds are buying. How much experience do they have as property managers? Flipping only makes sense when prices are rising and there are greater fools in the market for cosmetically enhanced porcine abodes (see rate discussion above).

Foreign Buyers: Spike in Chinese buying in CA this spring with Chinese government rules impacting the Chinese market. All cash foreign sales are bound to be overpaying in a low rate environment at the high end. Once the Chinese market cools and the Dollar strengthens, these high-end US homes will be sold (at a discount) to buy Chinese properties at an even bigger discount. As the dollar strengthens against EURO and Yen, we can expect to see a reversal of cash buyers from the US back to Europe and Japan.

Supply Side

Many factors are affecting the number of homes for sale in California: underwater loans, distressed distressed-inventory (HBR), rental/primary ratio change, low-rate lock-in, Prop 13, and rising prices (regular and short-sellers don't want to leave money on the table).

The important thing to note on the supply side is that many of the factors serve to increase inventory when prices rise. In some cases, inventory can rise abruptly. For instance when peak price levels are taken down and underwater owners can sell. Since demand decreases as prices rise, there is a self-limiting price ceiling.

And another thing, the rise in consumer confidence is due to every home being refinanced at 3.5%! If the refinance boom is over, where is everyone going to get their extra spending money? Second job? HELOC? Cash-out refi at a higher rate? How many mortgage brokers are going to be out of work when the refi machine stops kicking out ysp in its latest form? Let's see, rates up = lower purchase volume and zero refi volume.

What is the FED to do? If they decrease MBS purchases, the rates go up and the refinance economy dies. If they keep MBS purchases the same, then rates stay the same, and the refinance economy dies more slowly. If they increase MBS purchases, then the rates go down, refinancing continues, and housing prices rise. I'm betting on door number 3.

Appears the top is closer and sooner than I had thought in this round of the bubble.

Call it Crazy says

It might have a psychological affect that causes buyers to sit on the sidelines...

...or buy even more before rates go back up to 5.0 again!

last chance!

You can keep a deflating tire from going flat by continually pumping it up with air, but the leak will invariably get too big and you can't pump as fast as necessary. You'll probably be too tired and don't have any energy left to pump. At that point the tire is going to go flat and you can't stop it.

Oh, wait, scratch that. I capitulated two days ago.

Roberto Professor. Your investments are in good shape so no worries oh great one. However, despite your exceptional brain and analysis, I suspect even you are getting concerned about the pace and commentary of recent events. What else, aside from your massive ego, would explain the frequency and turnaround of your Pat Net posts?

robertoaribas says

Rates may eventually make a difference, but today, it is SUPPLY AND DEMAND. nothing else matters, today.

Rates will influence supply and demand...

robertoaribas says

AZ, using a $200K home for example, 20% down, $1500 tax, $700 insurance:
4%
payment = $955.53
5% payment = $1050.58

A $100 will make a huge difference because people have so much other debt to pay off. There are car loans, student loans, credit card debt. Every $100 more on the mortgage will limit who can afford the payment. New rules starting in June will exclude anyone paying more than 43% of their income on a mortgage.

waiting_for_the_fall says

A $100 will make a huge difference because people have so much other debt to pay off. There are car loans, student loans, credit card debt. Every $100 more on the mortgage will limit who can afford the payment. New rules starting in June will exclude anyone paying more than 43% of their income on a mortgage.

In the current market, a $100 difference is barely even noise to qualified buyers. Inventories are extremely low and the only people that can afford to buy are either:
a) Paying cash so they don't give a damn what interest rates are
b) VERY well qualified buyers taking conventional loans

With inventories being at 20% of the historic norm, that means that only the top 20% of buyers can play (as in, the bottom 80% is irrelevant). The top 20% may well have car loans and CC debt, but it is not enough to disqualify them from conventional financing like it is for the majority of Americans. That is the case NOW. Of course, inventories will eventually rise again and lending standards will probably become more lax, but that's not happening today.

For conventional financing, I am pretty sure that the max DTI was already 43%. Wells Fargo clearly stated so when we got our loan through them this month. Lending standards have been tight enough to disqualify MOST buyers for years now, and we've all seen how crazy the market has gone anyway.

robertoaribas says

Now, add in that 30% of the purchases are cash, so you are only affecting the other 70% anyways.

The reason why 30% of the purchases are cash is that the rates are so low in other asset classes. If rates rises (I don't think they will), cash purchases will decrease substantially.

Let me do the math for you. If someone can make 5% on a bond fund, $200,000 gives them $10,000 of income without any expenses. The $200,000
house makes ($1200 rent X 12 months)*0.9 (10% management fee) -$1500 property tax = $11450 and that does not include any fixes and depreciation. I would put my money in a bond fund.

Rates matter.

Roberto, what you are saying doesn't make any sense. Let me tell you how the 0.5% rate increase is affecting my house search. We have stopped looking at homes in the range of $800-850k because of that "small" increase. As a percentage of the interest portion of the mortgage payment, a 0.5/3.5 increase in rates is a 14% increase in interest!

Unless we choose to put more down, we are looking at a huge increase in monthly costs. Like everyone else we have other monthly bills that dictate our housing spending limit. All across the country, a super majority of buyers (70%) are doing this same calculation and arriving at a similar conclusion.

As for cash buyers, rising interest rates make cash buying more expensive too. There is a cash equivalency to every payment stream. I had 1yr CDs paying 5.7% in 2008 (thanks Countrywide). Now I'd be lucky to get 1%. The value of cash has fallen even more dramatically than rates! In terms of risk free income, cash is worth less than 20% what it was 5 years ago. If nominal 1yr CD rates double from 1 to 2% the value of the cash doubles. This makes buying with cash that much more expensive, thus depressing the amount buyers are willing to spend.

Think about it this way: if I am buying a house for $1M in cash, I am foregoing only %10k in annual income. If rates are paying 5%, then I am foregoing $50k in income. What is the difference in comparable rental property quality when you are paying $833/mo. vs $4167/mo.? Rates matter to everyone -- to the cash rich as well as the cash poor.

Interest rates will remain calm for the foreseeable future. I mean with the top 5% skimming off virtually every dime off the top and real incomes of the 95% that continue to fall, inflation is simply a quaint memory. I mean, the rich can only consume so many potatoes. Unless of course they decide to buy all of them to let them rot. Deflation is the boogyman that everyone should really be afraid of.....and those holding the bags full of money are. I predict rates well under 6% for the rest of my life.

Buster says

I predict rates well under 6% for the rest of my life.

You must be at least 89 to 92 years old.

Kidding aside, I'm afraid your prediction has a very high chance of becoming reality.

@SFace,

At this point, it looks like 2013 is the reverse of 2012. 2012 started slow and picked up a lot of steam going into the summer and the rest of the year. This year started with a bang right out of the gate so I wouldn't be surprised to see a much tamer market in the 2nd half of the year. This fall and winter will likely be a buyer's market again in my opinion.

My conspiracy theory is that the Fed wants higher rates here to try to cool down the stock market bubble. Also, to allow the banks to gouge the homebuyers who plan on buying before school gets back in session. They are going to buy no matter what so may as well skim a few extra dollars out of them. Then later in the year the Fed will let rates come back down. They will suggest more QE is coming. Or allow unemployment numbers to go back up. Anyways, the Fed will never raise rates substantially again. They will just lie about the real figures and try to jawbone the markets to go the way they currently want it to. Rates start edging up and they say things are getting worse(which brings rates down). Things start heating up and they suggest tapering...

Going by fundamentals rates should be much higher. If we used the same inflation calculation we used when Carter was president, inflation would be reported as being in the double digits today. The Fed would have to raise rates in kind, which is why they lie about the real rate. We also have numerous bubbles all over. Sorry, but 30% annual increases in real estate is not typical. Neither is a 150% rise in stock markets when conditions are worse than traders ever imagined they could get. A deficit and tripling of the money supply should not allow low rates either. Again, the Fed can't allow rates to go to their natural levels. They need them to be in a limited range. Maybe the bond vigilantes will come out of their coma? If not, expect rates between 2% and 5% for decades(or until we get some politicians who allow free markets and deal with our deficit).....

dublin hillz says

Back when I closed in May 2011, the rates were 5%.

And when I closed in October 2010 the rate had JUST dropped to 3.75%, since then the rate continued to drop and I felt like I missed out ... well, not really, but I'm feeling a warm fuzzy as the rates move above what I'm paying.

It's funny to hear people say a 4% 30 year fixed mortgage is a CATASTROPHE. Jezuz get some perspective people. In the 80s and 90s and early 2000s (pre 9/11) people would have given up their first born for a 4% mortgage. Rates were in the 8% range in 2000.

And now 4% is a CATASTROPHE? Give me a break.

Jambu Shambu says

It's funny to hear people say a 4% 30 year fixed mortgage is a CATASTROPHE.

The article specified the change in interest rate as being historically significant, but I agree that calling anything a catastrophe is funny.

What's really funny is that people think the interest rate is significant. What's important is the total amount of interest you will pay compared with the total amount of money you will make.

What a brilliant move to get people obsessed about their monthly payments. What a bunch of good, submissively willing workers.

Call it Crazy says

When you're trying to qualify for an over-priced house at 44% of your gross
income it is.... every 0.1% makes a difference...

Going in with 44% gross ratio is rather dangerous regardless of interest rates - if you are in a 2 income family, if 1 person gets whacked, you are in serious trouble, the only way out of that predicament is to have at least 6 months worth of savings and try to sell asap (or find another job). If the loss of the job were to occur within 3 years or less of buying and selling becomes necessary a substantial loss compared to renting is likely to occur.

mREIT stocks getting hammered because of this.

Cheeseus Sonofdog says

My conspiracy theory is that the Fed wants higher rates here to try to cool down the stock market bubble.

I can't imagine why anyone 18T in debt would want higher interest rates.

Mortgage Purchase Applications are at mid-90s levels.

Better find more investors...

FunTime says

What's really funny is that people think the interest rate is significant.
What's important is the total amount of interest you will pay compared with the
total amount of money you will make.

Whether you look at it on a monthly basis or a total cost basis, the interest rate has a HUGE effect on the total amount of interest you will pay, so I'd say it's pretty significant.

And if you want to do a rent vs. buy calculation, it is easiest to look at it on a montly basis as that is how most people pay their rent.

tatupu70 says

the interest rate has a HUGE effect on the total amount of interest you will pay

Completely agree. I tried and failed to write the point that considering the monthly bill without considering the 30 year bill can lead to decisions difficult to live-up to.

robertoaribas says

there is zero chance you are paying the same rent 30 years from now either. Look at your total rent over 30 years too then, if that helps.

It helps! Totally agree. My main problem with buying a house is that it takes a lot of time/money away from me now that could be used to grow over time.

I also don't want to live in Phoenix. I really enjoy San Francisco. Maybe someday I'll Winter in Tucson due to family ties.