Housing market rate hikes. Media doom and gloom or real hard times ahead?

I think do think it's bad news. It used to be that people would move every 7 years on average, which created churn in the real-estate market. People would sell their entry-level/starter homes and move to a nicer place, which created a secondary housing market for people who looking for starter homes. Older people might have sold their single-family homes for a condo or something with less maintenance.

People who currently own homes with "COVID mortgages" (such as myself with a 2.5% 15-year rate) aren't going to want to give up their rates for 6-7% mortgages, so they'll stay put longer. This results in a lack of real estate availability for everyone. Today's new construction (at least in my area of Raleigh, NC) isn't really appropriate for starter homes, and also isn't happening fast enough. They're all 2500sqft+ at $180-220/sqft. So people are stuck renting. Some will settle and buy townhomes just to own something.

So yeah, I think there are real issues here. The only "nice" thing about high rates is that it helped slow down the market. People aren't making stupid financial decisions like giving $50k-$200k above asking, offering insane due diligence fees or buying as-is with no inspections like they were during the peak.

Keep in mind that Tildes is international and real estate markets are local, so if you want the discussion to be about the US, it's a good idea to say so. There are some broad generalities, but, for example, 30-year fixed-rate mortgages are a US thing.

Even a US real estate discussion is going to be pretty broad and vague because there are a lot of state and local differences too.

"What's the real estate market like where you live" might be an interesting topic starter.

The primary issue with the US housing market is that the country has a severe shortage. This is especially true in major metros like NYC and LA where there's been underproduction of housing for decades. It's a combination of the Anglosphere's suburban development patterns since the post-war period along with increased NIMBYism, parking minimums, lot sizes, restrictive covenants, and onerous regulations.

Basically, the rates are only a problem because the principal is so high. Housing demand has, of course, increased with population, but the root of the issue is undersupply of housing. Even if rates go up, there is no bubble like 2008.

Its definitely slowing me down. Im an active landlord with a few houses that Ive been renovating and renting for the past 35 years.

But I bought one a year ago, here in Canada, at pretty much its peak price. I paid the asking price not over asking but it was still about 30% higher than it was a couple years before that. Its the first rental Ive owned that Ive seriously considered selling. I decided to gamble on the interest rates being high for less than 5 years, the typical term that people take on 30 yr mortgage and went with a variable rate mortgage (ARM in the US I believe)

So instead of locking in for 5 yrs at about 2%, Im now paying 6.75%. My payments have gone from a pretty manageable 1430 a month to 2155 a month. A jump of just over 50%. Combined with a jump in property taxes as well as insurance, my costs are up at least 55% from a year ago.

The bad part is that there's no way I can just pay that much more without downloading that cost to my renters. And all landlords with mortgages (which is most of us mom and pop landlords) will have to do the same. Thus rents are jumping here and renters are not happy. But the banks hold the purse strings and even if I had a big savings account, theres no way I can just dig up another 8600 a year for the extra payments. I feel bad for them, but they're going to be paying for the bulk of that, and they already know that my rate will be a bit lower than average so moving is only going to make it worse. Im careful to explain any rent hikes to them, and even show them comparable houses in the same neighborhood so they know Im not being greedy, but I am trying not to go backwards.

It sucks for all of us but it really sucks for them.

To elaborate on the effects of interest rate changes, in an abstract way:

Higher interest rates directly affect new construction by making it more expensive. Real estate developers need to borrow money during construction and that interest rate cost needs to get passed along as part of the purchase price for them to make a profit. If doesn't look like they can do that, they won't start the project.

And at the same time it affects buyers' costs too (unless they pay cash), so they can't afford to pay as much.

When sellers want more money and buyers aren't willing to pay, few sales happen. This is well-known and sophisticated players anticipate it. Real estate activity drops, sometimes by a lot and rather quickly.

But this is all very much the point when the goal is to attack inflation. A central bank can lower rates again when they think they beat inflation. Maybe it's good news for real estate then, but not now.

This isn't doom, it's a deliberate slowdown by a central bank with only one lever to pull. If it turns into doom it's because they have trouble predicting the future too. When they pull that lever, they do it carefully and gradually.

Sometimes people anticipate lower rates later, but that gets into how optimistic your financial projections are and the future is pretty uncertain, so counting on that doesn't seem wise. When construction is still going on, it's often because they're already committed and hope to muddle through.

To be very abstract, when interest rates go up, all asset prices should go down and that should be as true of real estate as it is of bonds. But with real estate there are a lot of complications. Sellers can be reluctant to "mark to market" (accept that their property isn't worth as much) so they often wait it out and hope things get better.

This assumption that you can pretend your assets didn't lose value and wait it out, muddle through, isn't just a home owner thing. It's pretty deeply embedded in banking, and that results in bank runs when it's wrong.

A little-known consequence is that when interest rates go up, the value of a fixed-rate mortgage to the bank also goes down. (All assets go down.) If you can somehow pay off the mortgage early by refinancing, the bank should in theory be willing to negotiate a better deal and take less than the remaining value of the loan. And that should help cover the increased interest you pay on a new loan. Making it easier to move.

At least in the US, banks largely count on people not knowing this and not being able to negotiate. They're not set up to negotiate. But apparently it can be done, sometimes, if you find the right person?

It's hard, so people stay where they are.

It doesn't have to be that way. I've read that in Denmark it works differently? You can buy your own mortgage at market price.

(I'm not actually an expert. Much of this is based on what Patrick McKenzie wrote. Errors are probably me misunderstanding something.)

Doom in what way? Interest rate hikes will have the dual effect of lowering demand while also making mortgages more expensive. In the US, after 2008 everyone all but abandon variable rate interest so existing homeowners will be pretty whatever about it. In the UK, variable rate is standard and it’ll hurt there more.

In the US it’ll probably be net good if you’re in an area with a lot of construction. There’s new supply, lower demand, and still the expectation that interest rates will go down and you can refinance. For zoning encumbered areas, it’ll be neutral or negative, as it also lowers supply of houses for sale in addition to making them more expensive via interest.

The price/rent ratio suggests either house prices have to go down, or rents have to go up, or maybe both.

The guy who predicted the last housing crash is warning of another housing correction. Shiller wrote the literal book predicting the dot com crash in 2000 and the housing crash in 2008 and warned in 2015 that bonds, house prices and stocks were high.

In terms of the general economy, the Cleveland Fed predicts a recession in one year as 80% likely, because the yield curve is inverted. The yield curve is inverted because inflation is high, and the Fed wants to engineer a gentle recession to get wages and inflation down.

The Fed is predicted to drop it's rates in 2024, which they normally do during a recession. The natural rate of interest is currently at about 2%, so mortgage rates will eventually come down to maybe 4% if there is a recession. If it is a severe recession, maybe lower. But so far the economy is holding up surprisingly well.

So if the recession is severe, house prices could drop significantly. If inflation remains sticky, then rents could go up. If we get stagflation, then probably house prices go down and rents go up. House prices have already stopped rising in the USA and dropped a little in the SF Bay area. This is all me spit balling of course.