by Lance Roberts
Despite much media rhetoric to the contrary - I have stated many times in the past that rising interest rates will negatively impact the real estate market. As I stated in "Chart Of The Day: Existing Home Sales:"
"As I stated recently the optimism over the housing recovery has gotten well ahead of the underlying fundamentals. The overarching problem is that the housing market is almost exclusively dependent on the continued push to artificially suppress interest rates combined with massive amounts of direct stimulus, and incentives, to bailout current homeowners and banks. This intervention is causing an artificial supply suppression which is likely to create a backlash in the future as the current supply/demand conditions are unsustainable.
While the belief was that the Government, and Fed's, interventions would ignite the housing market creating an self-perpetuating recovery in the economy - it did not turn out that way. Today, these repeated intrusions are having a diminished rate of return and the risk now is that interest rates rise shutting potential homebuyers out of the market. It is likely that in 2013 housing will begin to stabilize at historically low levels and the economic contribution will remain fairly weak.
This story will continue to unfold in the months ahead and the keys to watch for will be the level of interest rates, real employment and wages, and the effects of any fiscal drags from policy changes relating to reductions in spending and potentially additional taxes."
The mistake that mainstream analysts made was in the assumption that the recent increases the real estate market was driven by first time home buyers creating an organic market. The reality, however, was that the market increases were being driven by hedge funds buying entire blocks of homes to turn them into rentals along with the major banks in an attempt to recover their losses from 2008. However, the rush into the speculative rental market drove prices to higher, and when combined with the recent surge in interest rates, both priced potential home buyers out of the market and made speculative investment less attractive.
This begs the question as to what happens to the housing market when all of these speculative investors want to sell? Who will they sell to? This will likely be the basis of the next real estate related crash.
In the near term rising rates will likely to slow speculative activity. This was a point that I made in "Has Real Estate Sales Activity Peaked?"
"The latest data on existing and new home sales shows that we are likely getting close to the peak of the bounce from the bottom in housing activity seen in 2010. It is important to remember, as we have discussed previously, that there are only a certain number of individuals that, at any given time, are actively seeking to 'buy' or 'sell' a home in the market. Furthermore, individuals buy 'payments,' not 'houses,' so artificially suppressed interest rates are only have of the payment equation. When home prices increase to levels that begin to price buyers out of the market - activity will slow.
Finally, since many of the homes that have been purchased to date were for conversions to rental properties, when 'price-to-rent' ratios reach levels of low profitability - the demand for such activity will decrease. We are likely witnessing the beginning of that slowdown."
The latest data on mortgage applications, home starts and permits reflect the impact of what an even a small increase in interest rates does to both the psychology and activity in the real estate market. The chart below, courtesy of Zero Hedge, shows mortgage applications compared to the 30-year mortgage rates on an inverted scale.
As you can see the rise in interest rates in June sent mortgage applications plummeting by almost 50%. This is not surprising as the majority of those individuals that have the ability to refinance have been "serial refinancers" over the last several years chasing rates lower. With roughly 30% of homeowners either underwater in their mortgage, or with very little equity, the option to refinance has been scarce.
As stated above; housing is a function of what happens at the "margins" with the activity contained to those actively searching to buy a house versus those willing, or able, to sell. The problem is that the activity has been contained to a limiited number of individuals actually able to sell their homes versus a pool of artificial buyers will to buy large quantities of homes for speculative purposes. However, when rates rise, the profitability of the speculative investment declines and buyers halt activity waiting for lower rates. As demand falls so does associated housing activity. This creates a negative spiral as investors rush to sell to get out of their investments as profits are erased. The chart below shows housing starts and permits. Notice the decline in both series as interest rates began to rise in recent months.
For the housing market the recent rise in interest rates is extremely important. There are many hopes pinned on the rise in housing activity to continue to foster domestic economic recovery. The Federal Reserve has also noted the recovery in housing as a primary component of their monetary intervention decision making process. If the housing recovery begins to show signs of deterioration it will bring into question the entire recovery thesis keeping the current liquidity support programs in play for longer than anticipated.
The reality is that the Federal Reserve can not allow interest rates to rise significantly any time soon. The negative impacts of increased borrowing costs to the economy will be to great for the already sub-par rates of growth to offset. The recent spike in rates is likely to continue negatively impacting the housing data in the months to come.
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