Andrew Haigney
Just a few months ago, the Realtor community insisted that buyers should throw all caution to the wind and pay ridiculous premiums to win bidding wars. The message was: “Don’t even think about a home inspection – don’t you get it? There’s a shortage of real estate!” Thanks to a spike in interest rates, that sales mantra has been shelved and replaced with something potentially more toxic: “marry the property and date the rate!”
The thinking behind this latest sales pitch is that interest rates are on the verge of plummeting and home prices are set to soar again, so buy the property now and refinance your mortgage when interest rates drop. These kinds of high-pressure sales tactics are clearly aimed at generating sales commissions by preying on a homebuyer’s fear of missing out.
To be sure, at some point mortgage rates will be lower but the reason and timing of interest rate declines could be problematic for the latest Realtor sales strategy.
The first issue with the sales pitch relates to timing. “Dating” interest rates will likely be more than just a one-night stand. There are signs that inflation pressures are easing, and assuming that we don’t get more bad news on that front, we’re probably getting close to the end of the current Federal Reserve tightening cycle.
The problem is that the economy is still robust by most measures. With year-over-year inflation running at just under 8 percent, we’re pretty far from the Fed’s inflation target of 2 percent. It will likely take time for inflation to reach the Fed’s comfort zone, so you may be stuck dating that ugly duckling interest rate much longer than you think. Look no further than Fed Chair Jerome Powell’s statements last week to see how far we are from interest rate reductions.
The second concern relates to the economic conditions that would trigger a sharp reversal in Fed policy. For the Fed to start slashing interest rates, the economy would need to be in tough shape. Historically, periods of contracting economic growth and high unemployment don’t lend themselves to soaring real estate values. An all-out recession or a hard economic landing could be the second shoe to drop on the real estate market.
‘A Window of Opportunity to Deflate the Housing Bubble’
Last month, the Federal Reserve Bank of Dallas published a research report titled “Skimming U.S. Housing Froth a Delicate, Daunting Task.” The report noted that “…after a housing boom partly driven by pandemic–era FOMO beliefs, cooling market participants’ expectations is key to shifting house prices toward a more sustainable path and avoiding the peril of a disorderly market correction.”
The report concludes that, “Although the situation is challenging, there remains a window of opportunity to deflate the housing bubble while achieving the Fed’s preferred outcome of a soft landing.”
Translation: the Fed wants home prices to decline without completely tanking the economy. For the uninitiated, the Fed’s track record on engineering things like soft landings is less than stellar.
I don’t profess to know the path and timing of interest rate moves. Former Fed Chairman William Martin famously summed up the Fed’s mandate as “the job of the Federal Reserve is to take away the punch bowl just when the party is getting good.” Seven percent fixed-rate mortgages sharply cooled real estate activity, but the broader economy is partying on which leads me to believe that the Fed may still have some work to do.
The Biggest Sucker Bet Ever?
There is a consensus view that the real estate market supply and demand will remain well-balanced because people who got 3 percent mortgages during the boom won’t sell their homes because they don’t want to give up their low-rate mortgages. We don’t entirely agree with this line of thinking.
People will quickly wake up to the fact that by paying enormous premiums to win bidding wars, they gave away the benefits of their low mortgage rates. We don’t think that homeowners will sit idly by watching their hard-earned equity evaporate, just so they can brag about their low-rate loans. Ultra-low-rate mortgages may go down as one of the biggest sucker bets of all time.
Realtors coached their clients to throw all caution to the wind to win bidding wars; I fail to see how their latest sales pitch is any different. If you are in the market to buy a home, we are starting to see some pockets of decent relative value, largely from developers looking to hit the exits.
Buyers need to go into real estate transactions with their eyes wide open – what seems like a good deal today may not look so good in a few months. Valuation matters. Unlike mortgages, you only get one bite of the valuation apple.
Andrew Haigney is principal broker at Boston-based Batterymarch Group.
