Thursday, February 07, 2008

Manhattan Beach-Beach Cities: What's Up With Interest Rates

If you are looking for a new loan to purchase a home in Manhattan Beach or one of the Beach Cities or if you want to refinance your existing loan; you may be wondering where rates are going in the next few weeks. If you have been hoping to get a little insight from the "experts" in the field you may be disappointed.

I just received Dan Green's The Mortgage Reports where he has posted a link to Bank Rate's Trend Report. I love it.. even the "experts" are uncertain about where rates are going...

Bank Rate Panel Views on Where Rates are Headed:




In my Post wondering on is it time to buy I received the following comment from a reader...

Now why would anyone buy in this market that is clearly coming down, just because of interest rates? Interest rates always adjust, cost of houses are fixed.

It's a reasonable question and in a normal market, where nothing except price changes, it makes sense. However I knew from the comment that the person didn't understand my premise. The low rates over the last few years have been because of the FED slashing rates to banks. This is going to change. Inflation, not recession, may soon be the item of concern. Inflation means higher interest rates. The current market is similar to the market of the late 70's and early 80's not that of the 90's... a war that may be winding down, high energy prices, a credit market concerned with liquidity... all of these items shot interest rates up to 17%. Don't think it can't happen again.. it can.

If the change in rate by one point is about equal to a 10% price adjustment then if prices fall 20%.. which is unlikely in the Beach Cities.. and rates go up 2- 2.5% which is very likely... your monthly payment could well be higher. What the commenter missed was... what happens if your only option is higher interest rates not lower rates. Interest rates may not reach the current levels again for a long time.. if ever. You won't be able to refinance to a lower rate or even the same rate. The difference in the property tax based on the price is not nearly as large as the difference in the interest rate and monthly payment from 6% to 8%. A long term 5.5% -6% fixed rate is far more secure for a buyer then a slightly lower price and betting where rates will go.

Buyers need to get back to the idea of real estate as basic shelter and a long term investment. Stop expecting to make a profit in 12 months or you are going to walk away from the house. Long term is not 3 years. Long term is 7-10 years. That means getting a rate that isn't going to bounce around or need to be refinanced in 2-3 years. If you are betting that these low rates will continue, I'm afraid you may be disappointed. If you want to gamble go to Vegas.. if you spend enough money you will at least get a room, dinner, a show and drinks thrown in.

*** Update 02/11/2008

This is a report on the current interest rates in our area. These rates do not reflect the change in confroming loan rates. The report is courtesy of Bob Madden from Platinum Capital Group. ( click on graph to enlarge)


Anonymous said...

why would i want to buy a house today if i think mortgage rates are going to 10% or higher in the next year or two?

prices are set at the margin, and if the cost of capital increases and wages don't increase commensurately, then the marginal seller 2-3 years hence will be forced to lower price to sell his or her house.

kaye, i generally agree with your logic that one shouldn't try to time the market, but the vast disparity in the cost of renting versus owning in the south bay makes this a very dangerous time to buy in my opinion.

the annual cost of renting a high end home is roughly 3% of its current market value (e.g., we pay $7k/month for a 5-yr old house on the 500 block of the tree section that was recently appraised at $2.5m). my rent is fixed for 3 years. the total economic cost of owning this house (debt costs, interest tax shield, opportunity cost on equity, insurance, maintenance) probably runs ~8% per year.

if the implied cap rate on high end rentals moves from 3% to 5% - which would still represent a healthy spread to the ownership cost - then the mark to market value of the house needs to fall by roughly 35%.

if interest rates go up like you suggest, cap rates will need to go up in tandem (since risk-free alternative investments will siphon money away from the rental housing market). at the same time, the cost of financing a house will increase the total annual ownership costs. that will make renting an even better deal.

so if one thinks rates are headed higher, this is not a good time to buy.

as i see it, the strongest argument against south bay home price appreciation isn't the credit crunch, it's the arbitrage that exists between renting & buying. until high end rents approach $12-15/month, renting makes a lot more sense than buying to me.

obviously one way that the arb can close is if rents increase. i don't get the sense that the rental market is particularly tight. if anything, in recent months the rental inventory on WSR & Craigslist has exploded - especially in the townhome segment. this makes me wonder if we could start to see some stress in that part of the market (i.e., sand section "starter homes") sometime in the next year or two as prime Option ARMs begin to reset.

Kaye Thomas said...

Anonymous 10:54,
If you don't want to by a home then you shouldn't..but waiting for a number of years because you are hoping for prices and rates to fall is a sure way to not buy a house. Not everyone wants to buy.. a lot of people are very comfortable renting. Homeownership is not for everyone and it may not be a matter of money.

You are right about the marginal seller but I would venture that in our little slice of paradise the marginal sellers are fewer in number then you anticipate.

It may not be the optimal time to buy..however some people need to buy a home for a number of reasons. If you need to buy then doesn't it makes sense to take advantage of a lower rather then a higher interest rate.

I'm thinking this may be one of those small windows of opportunity that occur in markets at various times for a number of reasons. Once the window is over the market often reverts back and the window time becomes a benchmark.

Cap rates have never worked very well at the beach in all the years I have been selling real estate. You don't buy beach property and expect a positive or break even on the property for a long time.

People who buy here have historically bought for appreciation and long term income not short term. I know it makes no economic sense but it is the way it has always been... and I suspect it will continue that way.

There has always been a large gap between rents and mortgage payments. This is a tighter rental market then you may think as rents are going up in some neighborhoods. One of the reasons so many people bought in 2001-2004 is because with the low interest rates buying made more sense then renting.

However most people buy because they "want to own their own home" not because they see rents as high or low. They are setting down roots in the community. They want to talk about "my house". That may not interest you but it is a big factor for many buyers.

People who buy here are often buying for reasons other then "sound economic principles" which is what makes this market so strange to people who are new to the area.

I know people who buy homes for their kids to live in so they don't have to rent... and run a high negative to do it. Others have purchased because they know that overall the market here will continue to appreciate over time. You really see this in the sand section.

A number of people buy townhomes as starter homes and live in them for a few years then keep them as rentals and move on to single family homes. It may not seem smart to you but it has seemed to work here.

I have a friend who owns a number of properties in the MB sand section that he purchased over the last 40 years .. while he still rents a 1 bedroom apartment. Sometime in the next 6 months he is moving into one of them because he thinks he can finally afford to live in his own property.

We are a strange lot in the Beach Cities and it's often hard for people who have lived here for a short time to understand why people do what they do here. But it makes sense to those of us who have been here for a long time.

Anonymous said...

Kaye, stop trying to scare people into buying a home! You are a bit transparaent.

Now is the WORST time to buy since 1991....the inflection point has passed, but no real adjustements have occurred

And the marginal seller is pretty good at keep up appearances.....I know a guy that is technically completely and utterly bankrupt (too many Mesa "investments"), but his wife still has a nanny and spends here days at the spa.....he does not have a penny of equity left in his house (even at peak prices), and is having trouble with montly payments.

My guess is that there are quite a few people out there like that.

Kaye Thomas said...

Anonymous 9:21,

I'm not trying to "scare" anyone into buying.. If you don't want to buy.. don't buy! There are people who for whatever reason want/need to buy. If they need/want to do it now.. then they should be aware of what is happening in the market and what may be happening in the future.

My job is to provide information. What you do with the information is entirely up to you. That's why there are Democrats and Republicans.

This is a different market from 1991. It really is more like the one in 1980. Interest rates are going to play a big role in housing decisions in the next year.

You are right there are marginal sellers who are going to be in trouble but probably not as many as you think. There will always be a portion of the population who live well above their means and wind up in serious financial difficulty.

The demographics of Manhattan Beach are changing. The people moving into the area are not engineers and school teachers. Most of them have more then adequate financial resources.

It doesn't mean we won't see foreclosues or prices continue to soften. However we may not see the crisis so many are thinking will happen. There are a number of residents who will simply choose not to sell. They don't have to sell. Some will remodel while others will put off making a move until they feel the market is better.

If you do not have major increases in inventory then you may not see a market shifting into crisis mode. There are a lot of factors that need to occur before this market shows draastic changes.

If you are not comfortable buying then you should not buy. I wouldn't buy if I didn't feel comfortable with the market. That's a personal choice based on how you view the future.

Anonymous said...

Still too early to say....a year ago, Los Angeles still was on the books as having +5% appreciation, and has really only turned negative in the last few months.

If we believe (I think both of us do) that the more affluent areas are the last to be impacted by the downturn, we are really only a few months to a year at most of a local downturn.

And, we are most likely going into a finanacial driven recession which seems to be hitting the higher end consumer (unlike traditional downturns).

Let's wait a few months.

I have to say, I've plenty in the bank (earning interest) from selling my house and choosing to sit out when I moved to MB. I for one feel higher interest rates are acceptable if prices drop moderately since I have a decent downpayment and would have lower tax basis.

If you really are correct, and it is more like '80, and interest rates spike to 20%, I am even better off...that would surey impact prices even more, and another years worth of interest would make for a fantastic downpayment.

I very much doubt that interest rates will go up that much. No one could stomach it. Of course, high intest rates are an extremely high incentive for increasing savings rate, may be good for this country.

Kaye Thomas said...

Anonymous 11:22,
You are right.. it is too early to tell what will happen. If we wind up in a major recession with high unemploymnet among the upper management levels of big companies it could get downright nasty.

Nothing wrong with having cash. Higher interest rates would be a bonus for you on the money in the bank and would help to offset higher loan rates.

Don't think rates can't jump.. In October of 1979 I saw interest rates jump on a weekly basis. In roughly 6 weeks rates went from 10%to 16.5%. There was very little liquidity. If a loan was not funded by Wednesday you had to wait until the next week and hope the bank got some new money from an investor. You called everyday to every lender on your list to see who had money to loan.

When rates fell to 13% fixed there was dancing in the streets...

Believe me when I tell you rates can rise very high and very fast.

Anonymous said...

I think I understand the "premise" to your question
Kaye, in all due respect, you are in the business of selling houses. What if interest rates do sky rocket in the near future? The way I see it, prices will be forced down, back to historical levels that support middle incomes and inflation. Why overpay for a house in the first place? You can't change your house price. So what if you have an affordable monthly payment when rates are low. That is not what I define as home ownership. Why allow yourself to be enslaved by a mortgage just so you can talk about (your words) "my house." Carrying debt for the rest of your life does not equal home ownership. People should give serious thought to this before they agree to keep up with the Jones! Some of the" Jones" are losing their homes. Unless the" image of owning" is something you just cannot live without, better to rent in this declining market. The average owner today is effectively doing the same thing, with the added bonus of paying property taxes and maintenance costs. Banks will be much more comfortable lending on mortgages that incomes support...history shows us that rates can change, it also shows us (as in the case of Japan1980) that real estate can and will go down when the majority of incomes can no longer support the cost of a home.

Kaye Thomas said...

Anonymous 3:34,
You are right.. I am in the business of home ownership... or as you put it selling houses. I'm in this business because I truly believe in the concept of real estate ownership.

My Mother has rented four times in her life.. each time when building a home to live in. She is moving back to the mainland from Hawaii soon and at 85 she will be buying again as she sees renting as throwing away money. My Dad always said that everyone makes a house payment.. you just have to decide if the payment in going to be on your house or the landlord's house. I come by my views honestly.

Buying a house should not be a matter of "keeping up with the Jones'". I know that it can be but I don't think that is why most people buy a home. Why would you "carry debt for your whole life". What's wrong with living in a home long enough where where you actually pay down a chunk of the mortgage?

"Why overpay for a house in the first place? You can't change your house price. So what if you have an affordable monthly payment when rates are low. That is not what I define as home ownership."

How do you define home ownership? I find the above statement very interesting. If you own a home for 10-15 years isn't it better to have a low fixed rate monthly payment where you are paying off principle each month.

As pessimistic as you are about real estate I suspect that over 10-15 years even you would agree that home prices will go up. Do you think you will be ahead if you wait to buy ( while paying rent) to save XX% on the price but wind up with a significantly larger monthly payment every month.

If you save $100,000 on the price but pay an extra $100,000 in payments over the time did you really win in the long run? I suspect not.. especially if you filter in tax savings and the fact that after 7 years the amount you pay toward the principle begins to kick up.

Home ownership is a lot like winning the lottery.. nothing will happen unless you buy a ticket.

We can argue the merits or lack of them about buying a house but I believe that we simply have opposing viewpoints. I believe in owning a home.. and to use the vernacular have put my money where my mouth is. I bought in '91 at the top of the market and watched the value of my home go down by a lot and then go up by a lot. I have never regretted buying my house.. even when the price dived in the 90's.

This looks like one of those times when we'll just have to agree to disagree. We each have our point of view and I don't think either of us is going to change that view. But the conversation has been fun and enlightening for me.

Anonymous said...

Second time I've heard mention of Japan and real estate in the same sentence in three house. Previous was by a vice president of a very large corporation only a few miles from Manhattan Beach.

If "Japan" and "real estate" really do go together, yes, prices may drop for a generation.

Kaye Thomas said...

Anonymous 9:11,
Funny you should mention that.. I've heard/read reference to the Japan real estate crash in a number of places.

I don't know if it is because people really see similarities or if tthey are hoping for a similar market crash.

There is a lot of frustration in the general public by those who missed the 2000-2003 housing market. People who want to buy in certain areas will not be able to buy unless there is a major crash in prices.

I understand the frustration but wonder what will happen if the market only falls slightly... say 10% instead of 50% as many are hoping to see.

Anonymous said...

Japan's generation long meltdown was caused by easy lending and not writing off non-performing loans.

The US always smugly said that our banking system was more transparent, and we would write off excesses rapidly and get back to business.

However, the responses so far with not marking CDO's to market and now trying to send jumbos to freddie and frannie do not point in that direction.

A bit of trivia, the FED put out a white paper about a year ago that suggested implementing a Zero Interest Rate Policy (ZIRP) as a LONG TERM solution to US excesses if asset price deflation takes hold. Although dry, the comparison's are fascinating, and show that the FED is thinking along the same risk scenarios.

Kaye Thomas said...

Anonymous 9:30,

Zero interest rate ... what are these guys dong in the back room? Have they lost all common sense?

I disagree about upping the conforming loan limits for higher priced areas. I think that may prove to be a good thing as long as they also have strong rules about qualifying for the loans.

While most understand that the collapse of the entire housing/lending industry is not a good thing; a total bailout is stupid. Wall Street and financial institutions need to take responsibility for their actions or they will continue to act in an irresponsible manner.

The government pushed for de-regulation and chaos has ensued. If this policy sees the light of day then we really will headed for a Japanese type market collapse.

We need to bring back a sense of balance to the market. If that means banks will have to suck up losses due to bad judgment so be it.

Anonymous said...

The white paper is a technique to fight "japanese style deflation". Doesn't mean that it will be enacted, unless we do fall into a deflationary spiral as happened with Japan.

The paper may already be somewhat irrelevant with the way the financial markets are contracting, but it does show that the FED has a fear of deflation.

Kaye Thomas said...

Anonymous 10:27,
Thanks for the update.. It is of concern that the FED sees deflation as a potential threat.

Anonymous said...

I think what anonymous 921 is feeling (and me), is you tending to suggest that now could be considered a good time to buy.
Lets say you buy a stock at $'s now at $5...if u speak to the stock broker who recommended to buy this stock, I can guarantee you his response would be "You have lost nothing until you sell it'" I guess the same could be said with a home purchase...but the bottom line is this.
I can see buying a home if it is a steal of a deal or a special location that the buyer has been dreaming about..or if the buyer is loaded with tons of cash...but for the general public looking to buy, now is not the time to buy.

Kaye Thomas said...

Anonymous 2:08,
I do understand what you are both feeling. I'm not advocating this as a wonderful time to buy.

What I said was that if you have to buy within the next few months then now might be a good time before rates shoot up.

That is an entirely different statement. Some people do have to buy soon.. for a number of reasons. If that is the case then I would take advantage of the current lower rates...and I stand by that statement.

If you are not comfortable buying a home.. do not buy a home. If you think this market is going to go down by 50% wait and see what happens. A good deal for you might not be the same as a good deal for someone else. These are choices only you can make.

When it's my money I make the decision.. when it's your money you should make the decision.