Can Increasing Interest Rates Cause Local Home Prices To Go Even Higher?…And my apologies to Kansas.
Turn on the news, walk in to your local coffee shop and it doesn’t take long to hear somebody talking about the raging real estate market anywhere within a $50 Uber ride from Denver or Boulder. This new found personal wealth is a refreshing reprieve from many who limped out of the “Great Recession” 6 years ago. However, the increase in your bungalow’s value may not do you any good unless your going to move to Kansas and commute. Remember, you can’t take the mountains with you.
The other headline grabbing business news is of course the looming rise of interest rates (audible sigh). If you have been a reader of my articles over the last few years then you know I’m tired of writing about interest rates and why they are low and why they might or might not go up.
It seems the consensus is that when the Federal Reserve decides to start increasing rates all hell will breaks loose. Stocks will crash, bonds will poison you if you get near them and real estate will return to it’s natural state….worthless dirt. Let us clarify a couple of things. First, the Federal Reserve only controls the Fed Funds Rate which is the rate that banks lend each other money over night. Second, all other rates are dictated by supply and demand. Third, U.S. Treasuries are yielding more than their global counter parts and if the whole world, sans America, is keeping rates low, then the world will be buying American bonds keeping the American bond prices high and American interest rates….not so high. Let’s review.
I do think interest will go higher, but it will happen at a slower pace then many think. When the Federal Reserve increases rates for the first time, things will get shaken up a bit. Then things will get really, really…. normal. Historically periods of increasing interest rates are joined by a growing economy, stock market and yes home prices. Remember, the Federal Reserve tries to increase rates when things are going well.
Let’s talk about tho
se home prices. In the Denver/Boulder area home prices have increased substantially over the last few years. Not only have they made up for what they lost in 2008, they have reached all time highs in many areas. Recently, a local Realtor told me that he put in an offer for a client on a home with a listing price of about $250,000. The offer was $30,000 over the asking price. The offer was not accepted. That’s unbelievable! So why are home prices climbing faster than a cat in a flood? Simple. Some demand and very little supply. A quick search on realtor.com for single family homes for sale in Broomfield, CO a little berg of 65,000 people half way between Denver and Boulder revealed a total of 17 homes for sale. Three were below $400,000, Three over $1 million, and nothing under $380,000. I’m currently trying to figure out how to sell my garage. There is very little in the way of new building in the area. There are a few of reasons for that. First, many builders slowed operations around 2008 because of the recession and are slow to ramp up. Any house you see in construction now was contracted last year. Second, local municipalities have put building restrictions in place. Boulder and Broomfield counties are seriously picky about what can be built where. Third, Boulder and Broomfield Counties are running out of places to build. Broomfield used to be “out in the sticks” now Broomfield is urbanized and one of the major Business hubs of the Denver Metro area. “It ain’t your Grandma’s Broomfield.” However, if Grandma has lived in Broomfield for a while, she’s made a killing on her home.
Few Loans Few Buyers. With the 30 year mortgage rate near 4% banks are not taking any chances. It’s pretty much a public service that they issue any mortgages at all. If a bank lends money for 30 years at 4% and rates just go back to average, around 7% the banks lose a ton of money. Picture this, in the summer of 2008, money market savings accounts were paying over 4%. Think of that as a 1 day bond. Can you imagine a scenario where you lent somebody money at 4% per year, locked up for 30 years but you had to pay somebody else 4% just to borrow it over night. Now imagine it’s the same person. That’s just stupid right? Well that’s how banks feel. So you can be darn sure that if a bank is going to issue somebody a mortgage that person is going to need a down payment, an 750+ credit score and great job. If the banks know they are going to lose many on the best borrowers they sure aren’t taking any risks. Now fast forward to the apparently all but certain future of higher interest rates. Let’s say mortgage rates are normal at 7%. The banks think very differently and now they get to use their arsenal of solutions. At 7%, the banks can lower lending standards, issuing loans to more people. Sure, some of those loans may not work out, but at 7% you can afford to lose a few apples off the back of the wagon. Also, remember Adjustable Rate Mortgages (ARMs). Well they don’t make any sense when rates are at record lows. People “fix” loans when rates are low, they use ARMs when rates are higher hoping for better rates later. Banks have lots of tools available to mitigate high interest rates for eager borrowers. In addition to ARMs, there are interest only loans, balloon loans, 0% down loans, and more. And there is no law that says banks can’t issue loans over 30 years. Why not a 45 year mortgage? So, higher rates give banks more flexibility and allow the banks to take risk. That means more borrowers, more buyers, more demand. Remember those measly 17 home for sale in Broomfield, it only takes a few buyers to create a supply and demand imbalance causing price to go up. If rates go up, there will only be more buyers and remember Boulder and Broomfield counties are super picky about what can be built where. Don’t expect a lot of building around these parts anytime soon. Try Kansas.
So, how does this affect you? Well, if you or someone you know, love, or generally care about is thinking about buying a home or otherwise making a long term real estate decision, do it very soon. If you think the train is going go in reverse and come back to you just because you want it to, you’re silly. I’m a big fan of logic so let’s play this scenario out with a story. There is a Buyer named Higgy (my dog’s name). Higgy is thinking about buying a house. He’d like a 3 bed/ 3 bath tri-level in Broomfieldand the little guy needs about 1300 square feet. Today, if he can find one, that house costs about $300,000. He has $10% to put down and the rate on a 30 year mortgage is 4%. Here is how this looks. Graphic 1.1
Now let’s play out the scenario where home prices go up just 10% and interest rates go back to the historical average, 7%. Graphic 1.2 The same house gets much more expensive. Realistically, buyers don’t have that much flexibility in their budgets so since the payment went up $686 (53%) per month. Higgy is simply going to be buying much less of a home. If Higgy needs to keep his payment at $1,289 per month he’d now be looking homes that cost $189,000 today. After a quick search on realtor.com I’d say try Kansas.
Let’s say I’m half right and half wrong. Let’s say home prices drop by 10% but mortgage rates go to historical averages 7%. Graphic 1.3 As you see the effects of increased interest rates outweigh even significant price decreases. In fact, in order for Higgy to
benefit by waiting for the “home price bubble” to burst while mortgage rates rise, there would need to be a drop in prices of 30%. In Broomfield and Boulder counties, that hasn’t happened since NEVER! To give you some 
perspective, in the depths of the “Great Recession of 2008” Home prices in Broomfield dropped by 6% (zillow.com). Can you guess how much the “big drop” was in Boulder? Don’t try because not even in 2008 did Boulder home prices go down. So if you’re waiting for financial Armageddon to come so you can “catch the bottom” good luck. Maybe Grandma will rent you her basement? Not to throw salt
on the wound, but in Broomfield, rents are up 40% over the last five years. Rock-Chalk-Jay Hawk! (for non-basketball fans, that’s the Kanas Jay Hawk’s cheer)
My firm, Higgins & DeYoung Wealth Strategies is a financial planning and investment firm in Broomfield, Colorado. As financial advisors,
why do we care about our clients real estate situation? We care because proper planning isn’t about just investing your retirement funds in stocks and bonds. It’s about making prudent decisions across the full scope of your financial world. We developed a program called MyStrategy™ to address the unique financial needs of our clients. Part of the MyStrategy™ process is to create a document called Foundations. Foundations accounts for all of your assets including real estate. In order to make the best decisions you must account for everything you have. If your broker can’t have these conversions with you or won’t have these conversations with you, it’s probably time you consider becoming a client of Higgins & DeYoung Wealth Strategies. Each of our clients has multiple, licensed advisors helping them make the best, most logical decisions so that your strategies help reach your goals.
