Some of you are old enough to remember the exorbitantly high mortgage rates of the eighties, when the average 30-year fixed rate mortgage peaked above 18%. With mortgage rates so inflated it’s almost a head-scratcher to figure out how anyone could afford a home back then. Of course, the answer lies in real estate values that were much lower than today. Just for giggles, let’s take a look at 1980 U.S. median home values by state, both unadjusted and adjusted for inflation to 2000 dollars, side-by-side 2017 figures.
1980 and 2017 Median Home Values
Note: To adjust for inflation, the 1980 median home values were adjusted to 2000 dollars using the appropriate CPI-U-RS adjustment factor.
Source: U.S. Census Bureau, Housing and Household Economic Statistics Division – Last Revised: June 06, 2012 (1980 Unadjusted and 1980 Adjusted for inflation to 2000 dollars figures). U.S. Census Bureau, 2017 American Community Survey 1-Year Estimates (2017 figures).
For you millennials out there, I’m sure you are salivating over the idea of a mortgage under $100,000. Then again, possible student loan debt near or above $100k – and let’s not forget those credit cards – may have put your total monthly debt payment right back in the ballpark of what you would pay for a mortgage today.
So Where Are Mortgage Rates Today?
If you are a homeowner, particularly one with a mortgage rate north of 5%, hopefully you have evaluated the opportunity to refinance at historic lows over the past five years. No one can predict the direction of interest rates from day-to-day, but at this stage their trajectory seems to be upward as the 30-year fixed bottomed out at 3.35% on May 2, 2013 (Source: Federal Reserve Bank of St. Louis).
According to FreddieMac’s Primary Mortgage Market Survey®, U.S. weekly averages as of 10/25/2018 for adjustable and fixed rate mortgages are as follows:
“Concern that higher tariffs would dampen economic growth helped keep rates from climbing throughout the summer,” says Danielle Hale, chief economist with Realtor.com®, “but as the economy continues to prove resilient, mortgage rates are expected to continue their upward march.” When compared to rates historically, current rates are still low. The chart below puts current mortgage rates in perspective.
Did you know the average 30 year fixed mortgage rate over the past 30 years (1987 to 2017) is 6.69%?! (Source: Freddie Mac)
Source: Freddie Mac, 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, October 24, 2018.
What is Causing Higher Mortgage Rates?
Many believe the rise in mortgage rates is attributed to the Federal Reserve’s gradual increases in the federal funds rate, but this is factually incorrect. The Fed only controls short-term interest rates through rate hikes. The market controls long-term interest rates and the 10-Year Treasury Note yield, which is one of the most widely tracked government debt metrics in finance, serves as a benchmark for fixed mortgage rates and interest rates of other debt instruments as well, such as corporate bonds. The fed funds rate only comes back into play when one is looking at adjustable rate mortgages (ARMs) or home equity lines of credit (HELOCs) because they are indexed to short-term interest rates.
For those that enjoy delving into details, interest rate levels are a factor of the supply and demand for credit, meaning increased demand for money or credit will raise interest rates. Any reduction in demand will decrease rates. Conversely, increased supply of credit will reduce interest rates while a decrease in supply will increase them. Inflation can also be a key determinant in interest rate fluctuations. A rise in the inflation rate often corresponds with a rise in interest rates because lenders will demand higher rates as compensation for the decrease in purchasing power of the money they will be repaid in the future (Investopedia).
If none of that made sense, it’s okay! A financial advisor can help make sense of interest rate movements and what they may mean for your household.
Mortgage Rate Calculator: Buyers
Higher interest rates make borrowing more expensive for home buyers. Without a higher down payment, climbing rates can push some homes out of reach. LendingTree’s home affordability calculator is a helpful tool for prospective home buyers who seek an answer to the question: “How much home can I afford?”
For those with established credit and savings, there are a number of options that exist in the marketplace today. However, no two locations present the same opportunity and buyers must be highly selective (but flexible) in choosing their primary residence, rental property or vacation home.
How to Afford a Mortgage in a Tight Housing Market
Generally, when housing inventory is low and home buyer demand is high, home prices tend to go up. This means in many markets around the country, buyers are simultaneously squeezed by rising interest rates and home prices. To make matters worse, rents are rising. It’s no wonder why home affordability is steadily declining, especially among millennials, low-skilled workers, low-income and even moderate-income families.
The two major contributors to low home inventory currently are a lack of incentives to sell among existing homeowners and building constraints among homebuilders. According to the latest data Forbes sourced from CoreLogic, “Homeowners just aren’t looking to sell their properties. In the country’s hottest markets, 41% of renters plan to buy a home in the next year. But homeowners? A mere 11% are even considering selling in that same period.” Unlike previous years, existing homeowners do not see a need to put their property on the market because they would be selling into a rising interest rate environment. In other words, they would be losing the benefit of a historically low 15- or 30-year mortgage rate and would have to pay more in the current marketplace to purchase a home of equal value to their existing home.
Homebuilders are also contributing less to the overall supply of housing because they are encountering higher building material costs and labor costs coupled with diminished availability of finished lots and steep regulatory barriers. For example, the Trump Administration’s 20 percent tariff on imported Canadian lumber is only one of several reasons material prices have soared. This could be the reason why the majority of new construction lies in the mid to upper tier price points.
In a press release, HotPads’ economics team pointed out that with a median home value in the U.S. of $216,000 (20 percent down payment = $43,200), “If a renter making the median income saves 20 percent of their income each month they would have enough for a down payment in 77 months, which is nearly six and a half years.” Earlier this month, ATTOM Data Solutions released is Q3 2018 U.S. Home Affordability Report, which shows that the U.S. home prices in the third quarter were at the least affordable level since Q3 2008 – a 10-year low.
How to Plan Financially in a Competitive Real Estate Market
Just like if you were shopping for a car, it helps to obtain financing before searching for a home. For starters, it puts you in a great negotiating position to compare mortgage offers from several lenders and choose the best terms for your needs. Second, you have a slight edge over other interested parties if you approach a seller with financing already in place (documentation in the form of a “mortgage pre-approval letter”).
Next, although it may seem obvious, improve your credit score. Improving your score is more than just a matter of qualification. It is also a factor lenders will consider when determining the interest rate they will offer you. Half of a percentage point may not seem like a lot, but it can result in tens of thousands of dollars in savings over the life of a mortgage. Basic rules for improving your credit score include bringing any past due debts current, making all payments on time (every time), and reducing balances on credit cards.
Go bold by bidding competitively and limiting contingencies. A seller’s market is not the time to submit a low offer as your starting bid. Put down a higher down payment if you can. Also, it is not always the highest offer that prevails but the path of least resistance to a sale.
Last of all, if affordability is an issue, don’t be too picky. Consider older listings and fixer-uppers. Remain flexible in choosing a geographic location to live in. Ideally, you would move to an area where you could maintain or even increase your income, but realize lower real estate values.
Click on the image below to view a data visualization with historical prices by state from 2005-2017.
For a more detailed look at median list prices and other local market trends, click here.
A new study from GOBankingRates determined each state’s average monthly mortgage payment based on the median list prices in the state and the average APR on a 30-year fixed rate mortgage. Then, assuming that 30 percent of your monthly income is devoted to this specific housing cost, GOBankingRates worked backwards to determine the ideal income that would allow you to afford that average mortgage payment.
Future Outlook For Mortgage
Danielle Hale, Chief Economist at Realtor.com®, says…
“One potential tailwind for existing home sales is a possible shift in the housing market balance. For the last few years shoppers have struggled with low inventory and fast-rising prices. There are signs that the tide could be shifting in favor of buyers with more new listings coming up for sale, causing overall inventory to pick-up in some markets and listing price cuts to become more common. While it’s not yet a buyer’s market in most areas of the country, these changing conditions mean that sellers may need to be mindful of their competition, as buyers have been for years.”
On October 3, 2018, the firm’s Director of Economic Research, Javier Vivas, published a series of insightful takeaways in their REALTOR.COM® MARKET RECAP: Housing Inventory Starts Long Uphill Road to Recovery (September 2018). In a nutshell, he uncovered:
- National inventory stops declining as new listings spike
- Largest markets seeing faster inventory recovery
- National price gains continue to moderate
“San Jose, Seattle, San Diego, San Francisco and Nashville were the five markets with the biggest inventory jumps over last year, all posting increases of 31 percent or more. Also, Chicago and Miami join Dallas, Boston, Los Angeles, New York, as other major markets where inventory is rising over last year. In contrast, Indianapolis, Milwaukee and Oklahoma, Pittsburgh and Philadelphia were the top three markets with the biggest inventory drops over last year, all posting decreases of 10 percent or more, and all priced below the national median, as buyers follow the affordability trail.”
Mortgage Rate Calculator: Sellers
What sellers have going in their favor is a solidly upbeat U.S. economic story. U.S. consumer confidence, jobs growth and stock markets are all at, near, or have recently reached highs, while unemployment is at a low. Buyer demand is strong and not just because of the economy. Just like sellers, buyers have observed a rise in interest rates and they seek to lock-in their purchasing power and minimize future interest costs. Plus, millennials, the largest generation in the U.S. labor force, are at and growing to an age when one starts thinking about building a family and purchasing a home.
Higher interest rates don’t just affect buyers. Sellers can be impacted too by a decrease in market bids, which can also lead to an increase in housing market inventories and downward pressure on listing prices. Although rising interest rates have not dampened buyer demand at current levels, they could have an adverse effect on home prices if higher rates begin to impact home affordability in a more meaningful way. And although housing affordability is a term that is often location-specific, Q2 2018 numbers put out by the National Association of Home Builders/Wells Fargo Housing Opportunity Index show that housing affordability across the board has now reached a 10-year low.
“Tight inventory conditions and rising construction costs are factors that are holding back housing and putting upward pressure on home prices,” NAHB Chairman Randy Noel said. “Meanwhile, tariffs on Canadian lumber imports into the U.S. are further eroding housing affordability.” Click here to view the National Association of REALTORS® 2016 Affordability Index of Existing Single-Family Homes for Metropolitan Areas (the most recent version publicly available on their website).
As a seller, you will want to know if you are selling into a weak market.
Housing Market Analysis By Area
To determine the best places to sell a home you want to look at:
- The percentage of homes with a price cut in a given area (the less the better)
- The average number of days homes are on the market in the area you are targeting (the less the better)
- The sale-to-list price ratios of homes in the neighborhood, city or state you are evaluating (the higher the better)
- Above 100%: the home sold for more than the list price
- Below 100%: the home sold for less than the list price
- The share of buyers shopping for a mortgage before identifying the house they want. Buyers with financing in place are more appealing to sellers and can compete with cash buyers.
- Average down payment percentage. Having a higher amount of money saved for a down payment can enable you to borrow more money or be offered a lower interest rate, allowing you to make a stronger offer.
- Percentage of buyers who have prime credit (above 680). Borrowers with higher scores have more financing options to make more competitive offers.
The Realtor.com Market Hotness Index exposes how local areas are experiencing fast moving supply and rising demand. Using proprietary insights on buyer activity and the most comprehensive data on active inventory, the analysis breaks down demand and supply dynamics to rank metro areas, counties and zip codes relative to the rest of the country. Realtor.com examines listing views by market as an indicator of demand and median days on market as an indicator of supply.
Financial Factors When Selling a Home
In addition to some of the factors noted above, there are a number of other key considerations sellers should incorporate into their analysis. For starters, is the population growing in the area of interest? Common sense would dictate that the market is tilted in the favor of sellers if the population increases in an area where housing inventory is already tight. In other words, if market demand is already strong among the existing populace would it not only get stronger as more eligible buyers move to the area? Population growth can be viewed in a given area by using the U.S. Census Beureau’s American FactFinder.
A second local characteristic to consider is jobs growth. Are new companies moving to the area that will not only attract out-of-town talent as mentioned above (population growth), but also lift some local residents into a pool of eligibility? Depending on the size of the organization and local tax laws, their presence can also generate a spike in tax dollars that, in turn, can be reinvested back into local communities and make them even more attractive as a living destination. Local job market trends can be accessed through the Bureau of Labor Statistics.
Lastly, what level of home builder activity – or lack thereof – is taking place in your area? Yes, housing supply is affected when existing homeowners choose whether to put their homes on the market, but it is equally true that builders have a say-so as well. Less construction could equate to higher home prices if the end result is a decline in housing inventory.
A one-stop resource for a variety of useful analysis tools can be found at BuilderOnline.com.
Existing Homes Sales Data
If you are interested in viewing homes sales transactions, nationwide or by region, that have already occurred, you may want to view existing home sales data.
Existing home sales is a lagging indicator released monthly by the National Association of Realtors (NAR). It measures sales and prices of existing single-family homes, condos, and co-ops in the United States. The September 2018 Summary (since unpublished) produced some powerful insights. Below are some of the key takeaways:
- The Year-over-Year percent change in total existing home sales was negative nine out of the past twelve months.
- First-time buyers represented 32% of overall sales (29% in Sept 2017).
- The percentage of sales to investors dropped from 15% to 13% Year-over-Year.
- Existing home sales to the Northeast, Midwest, South, and West were 13%, 25%, 41%, and 21% respectively.
- Sales within the $100-250k range represented 40% of total sales and $250-500k represented 36%, yet these two ranges saw the largest percentage declines in sales from a year ago at -18.3% and -9.1% respectively. The $500-750k range was not far behind with a -7.7% decline from a year ago.
Mortgage Calculator: Investors
Despite rising interest rates, real estate offers some compelling investment opportunities. What actions an investor takes all depends on whether they prefer to invest in physical real estate directly or indirectly through market securities and non-tradeable securities. Each option has its own distinct advantages and disadvantages and investors should consult with their financial advisor before making any investment decisions.
First, let’s take a look at investing indirectly in real estate, where we will explore new guidance from the U.S. Department of the Treasury that gives investors the ability to receive a three-part tax break, including on unrealized capital gains. Additionally, we will cover real estate investment trusts (REITs), real estate crowdfunding, and U.S. floating rate notes. Next, we’ll delve into direct real estate investing and the prospect of renting versus flipping a property.
Three Part Tax Break Associated with Opportunity Zone Funds
Two weeks ago on Friday, Oct. 19th, the U.S. Treasury Department released rules designed as a guide for a new community development program established by Congress in the Tax Cuts and Jobs Act (TCJA) of 2017. The program focuses on Opportunity Zones, and provides tax breaks for investment in these select economically disadvantaged areas nationwide + Puerto Rico. “We want all Americans to experience the dynamic opportunities being generated by President Trump’s economic policies,” said Treasury Secretary Steven Mnuchin in a press release heralding the new rules on that Friday. “We anticipate that $100 billion in private capital will be dedicated towards creating jobs and economic development in Opportunity Zones.”
The TCJA of 2017 allows taxpayers to defer capital gains taxes, within 180 days, on profits from the sale of any investment or property until December 31, 2026, as long as the profits are reinvested in Opportunity Zones. Unlike other capital gains deferral provisions in the tax code – such as like-kind exchanges – taxpayers need not reinvest the total investment amount; only gains from the sale of assets. Since money cannot be invested in these zones directly, investors must divert capital into Qualified Opportunity Funds (QOFs) that, in turn, invest in businesses (from real estate to tech start-ups) located in Qualified Opportunity Zones. By self-certifying, eligible real estate developers and business owners can become their own QOF, thereby maximizing control over their investment, should they choose.
Besides the tax-deferred growth experienced in the fund, a secondary set of tax features pertain to the holding period. If a taxpayer invests unrealized gains in the fund for five years, their capital gains tax will be cut by 10% (10% step-up in tax basis); if the investment is retained for seven years, it’s cut by another 5% (15% total). If an investment is held in the fund for 10 years, the taxpayer still receives the 15% step-up in basis on the original gain AND there is no tax owed on new gains accrued after investment in a QOF. The second of the two tax benefits just mentioned (for a 10-year holding period) is called the “permanent exclusion”.
Altogether, investors have the ability to obtain a three-part tax break. The IRS has compiled a list of Frequently Asked Questions concerning Opportunity Zones. You should consult with tax, legal and accounting advisors before engaging in any transaction.
Explore a map published by the Economic Innovation Group to see which communities have been designated as Opportunity Zones. There are nearly 8,700 census tracts comprising 35 million Americans.
Real Estate Investment Trusts (REITs)
A REIT (pronounced “reet”) is a company that owns, operates or finances income-producing real estate. REITs by law must pay out at least 90% of their profits as dividends to investors. Although non-traded REITs – not traded on a public exchange – exist, this article will focus exclusively on publicly-traded REITs. There are two types of publicly-traded real estate investment trusts: Equity REITs and Mortgage REITs. Equity REITs own primarily commercial income-producing properties such as office buildings, shopping centers, apartment buildings, etc. Mortgage REITs on the other hand are made up of underlying mortgages, whether through direct financing or purchasing of existing mortgages and mortgage-backed securities.
REITs are highly sensitive to rising interest rates as their yields start to look relatively less attractive versus fixed-income alternatives, but investors need to consider the total return picture for the investments rather than just the current yield.
As explained by Nareit…
“Asset prices often decline as the immediate response to a rise in interest rates because investors perceive higher interest rates will reduce the present value of future cash flows from investments. If future cash flows are not expected to rise, such as income from bonds, then rising interest rates would have a clear negative impact on their asset values. Rising interest rates, however, often reflect economic growth that can boost REIT earnings and, ultimately, share prices. History shows that REIT share prices have often increased during periods like the present one when the Federal Reserve shifts from a stimulative policy stance to a neutral position.”
However, all REITs are not created equal and one needs to look at the sector(s) the REIT invests in to determine if there are separate factors, outside of interest rate movements, that could negatively impact the investment. For example, REITs that invest in shopping malls could experience declines for reasons independent of interest rates, as more consumers move towards online shopping venues. Data centers present a more compelling investment opportunity, “With the growing adoption of cloud and colocation into enterprise IT strategies,” according to CBRE research. “Many end users are exploring various options to monetize existing assets, minimize data center costs, and shift the burden of those costs from capital expenditures to operating expenses and in turn redeploying capital from cost savings to support core business initiatives.”
As more enterprises shift to cloud and outsourced/third-party solutions, the sector could be viewed as more attractive than some others in the REIT space. Still, investors must be diligent as technology advances and enterprises move towards a digital infrastructure. Key takeaways from a Gartner report state:
- The role of the traditional data center will be relegated to that of a legacy holding area, dedicated to very specific services than cannot be supported elsewhere, or supporting those systems that are most economically efficient on-premises
- As interconnect services, cloud providers, the Internet of Things (IoT), edge services and SaaS offerings continue to proliferate, the rationale to stay in a traditional data center topology will have limited advantages
On April 13, 2018, Gartner analyst David Cappuccio was quoted in The Data Center is Dead, and Digital Infrastructures Emerge as saying, “By 2025, 80% of enterprises will have shut down their traditional data center, versus 10% today.”
Mortgage Calculator and REITs
Click here to view investment performance by property sector and subsector. Furthermore, historical data tells us REITs outperform other major asset classes over time. Click here to view the performance of stocks, bonds, long-term government bonds, and treasury bills between 1972 and 2016.
Real Estate Crowdfunding
Simply put, real estate crowdfunding venues match a batch of investors to borrowers who need funding. Unlike REITs, whose underlying real estate portfolio is crafted by the company selected, real estate crowdfunding allows investors to assemble their own properties within a portfolio. Investors can align portfolios to their specific investment objectives by routing capital on a project-by-project basis. Some of the major players in the industry are RealtyShares, Fundrise and Fund that Flip.
The downside to investing via real estate crowdfunding sites is they are less liquid than REITs that are traded daily across public exchanges. The due diligence process can also be tedious. Joseph Hogue, chartered financial analyst and owner of Crowd 101, a crowdfunding website, says, “Only investors willing to take the time to review property and investment documents should invest in crowdfunding. Those that want a more passive investment should elect to invest in REITs.”
U.S. Floating Rate Notes
Floating rate notes (FRNs) are 2-5 year debt instruments with variable interest rates. They are often tied to benchmarks such as the U.S. Treasury bill rate, LIBOR, the Fed funds rate or the prime rate. The idea is that yields will rise and fall with interest rate movements, unlike bonds, for example, that have an inverse relationship with the rise and fall of interest rates. FRNs can be purchased as mutual funds or exchange-traded funds (ETFs), or even directly from select corporations and governments. The U.S. Treasury began issuing 2-year FRNs through Treasury Direct, banks and brokers in January 2014. Interest income is exempt from state and local income taxes, but subject to federal income tax.
Mortgage Rate Calculator: Renting vs Flipping
To rent, or to flip. That is the question. Increasing home prices have swapped the balance away from homeownership and towards renting in hundreds of counties around the country. One can extrapolate from the previous statement and facts presented earlier in this blog post that when interest rates rise – at least in the current environment – fewer people buy and more people rent (they have to live somewhere, right?). If more people are renting, strong demand would imply landlords could raise rents continuously without affecting vacancy costs. Higher rent equals increased cash flow and net operating income (NOI).
The Realtor.com Rent vs Buy Report (since unpublished online) compares median monthly costs of renting and buying relative to median income in 3,142 US counties. By September 2018, renting costs have gone up in 73% of the counties, and buying is cheaper in 34% of counties. This interactive report allows users to zoom in their specific areas of interest. Choose a state and hover over each county to see details.
*Buying costs are calculated based on realtor.com county-level residential listing price data for August 2018. Rental prices are sourced from the US Dept of Housing and Urban Development (HUD) data for 2018 rental estimates 50th-percentiles. Household incomes data comes from Nielsen Pop Facts Demographics 2018. Top 10 County details provided for counties with populations of 100,000 or greater.
Disclaimer:
Mink Wealth Management does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
This blog post contains external links or pointers to information created and maintained by other public and private organizations. These links and pointers are provided for the user’s convenience. Mink Wealth Management does not control or guarantee the accuracy, relevance, timeliness or completeness of this outside information, and expressly disclaims liability for errors and omissions. The inclusion of links or pointers to particular items is not intended to reflect their importance, nor is it intended as an endorsement, recommendation or favoring by Mink Wealth Management of any views expressed or products or services offered on these outside sites.