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In the 1990s, dot-com mania swept the nation, and swelling investment portfolios were the toast of the town. The real estate market is surely today’s version of that hot topic (Internet searches for “housing bubble” turn up almost one million hits). The public is fascinated and seduced by the enormous wealth potential created by an appreciating asset held by two-thirds of U.S. households. What will happen if this appreciation stops, or worse, if housing prices collapse?
How We Got Here
Home prices have risen about 11% annually since 2002. Northeastern states lead the charge— appreciating about 20% annually—with the South’s 9% annual rate bringing up the rear. Most investors don’t realize that stocks have in fact been appreciating more than real estate since 2003. The S&P 500’s annual rate of return alone is about 18%. Many investors—still stinging from out-sized losses suffered during the dot-com crashes—understandably gloss over the stocks’ superior return. Real Estate, for investors reluctant to reenter the stock market, is today’s new “hot dot.”
The cause for real estate’s recent growth is twofold—increased household formation and a declining mortgage rates. The former is an issue of demand outstripping supply: new housing construction rates have remained relatively constant since the 70s while family demand for new homes has skyrocketed by about 75%. As a result, prices have been rising annually by about 6.5% since 1970—buffered by legislation in 1997 exempting the first $500,000 of profits from any home sale. In addition, most real estate investors enjoy a full deduction of mortgage interest (carrying charges) for their investment. Imagine modern investing if stock prices garnered the same tax benefits!
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Several valuable resources for Mortgage Interest can be found on this site...
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The mortgage rate decline adds fuel to the real estate fire—falling by more than a net amount of 1% between 2001 and mid-2003—reducing monthly payments for home ownership almost 20%. Adjustable rate mortgages fell even more, with three-year adjustable rate mortgages down about 1.25%, reducing monthly cost by 35%. Lower rates increase the number of qualified first-time homebuyers while prompting many homeowners to refinance and withdraw funds accumulated in their “equity piggybanks”.
The general cry among today’s economists and financial advisors is that our economy is now driven by newfound “borrowed money.” While outstanding mortgage debt relative to household income has climbed 9% since 2002, these same households are simultaneously using their mortgage debt to restrain credit card borrowing—realizing a 10% decline in credit card debt to household income, if not more. Households are shifting from expensive credit card debt to cheaper, more tax-efficient mortgage debt and reducing the cash flow needed to regularly service it.
Most U.S. households today dedicate an estimated 13.5% of after-tax income to all debt service, down from 14.8% in 2000. This decrease won’t cause a one-time bump in consumer spending, but should have a longer-term effect on consumers’ disposable income. With the prospect of stabilizing mortgage rates, we see no further benefit accrued from the recent spate of mortgage refinancings.
A Soft Landing
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The looming specter of higher interest rates threatens to reverse the real estate appreciation trend. As the Fed drives up short-term interest rates, those seeking adjustable rate mortgages are experiencing a sharp rise in entry-level home ownership costs. Longer-term fixed rates have hardly risen, but the Fed hasn’t completed its plan. Prospects of increases in both short-term and long-term mortgage rates will serve to increase mortgage financing costs, impacting a first-time home buyer’s ability to qualify for loans and bringing the “refi” market to a screeching halt. This tide of real estate appreciation will ebb as soon as we see upward pressure exerted on interest rates.
Regardless of how mortgage rates change, the general pace of real estate appreciation will taper. To maintain the recent appreciation trend, two highly unlikely outcomes—federal legislation encouraging new real estate leverage or a steady drop in mortgage rates—must occur. Look instead for softening real estate demand with a corresponding drop in real estate values. That said, we do not believe there is a real estate bubble or foresee a drop in real estate prices large enough to upset our economy and financial markets.
Conclusion
Investors expecting a continuation of recent real estate growth trends are in for major disappointment. Without lower interest rates, favorable changes in tax policy, or unexpected demographic shifts in population, real estate price appreciation will return to its traditional long-term 6.5% return rate. This reversion may not take place until real estate prices stage a pullback, and in certain parts of the country, this pullback may be more pronounced. Rest assured that no drop in real estate prices will resemble the dot-com bubble that burst in the 1990s, leading us to believe that, when compared to real estate, investing in the stock market may offer better potential over both the short- and long-term.
| Ray Corbett |
Editor -
Mortgage Interest
Facts,
Information
Resources And Benefits
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The Single Most
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The Four Most
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1.)
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2.)
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3.)
Does the company have a Terms Of Service agreement on their website?
After you have selected a
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services. If you don't see a terms of use or service agreement on the home page, ask for a copy to be emailed to you. |
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4.)
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Finally,
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Check
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