It is hard to believe that the words investing and real estate would be used in the same sentence considering recent events. Ultimately the decision lies with the investor if they feel it is the right time, but in this discussion we will go over some important considerations that should weight on that decision.
The goal of investing in real estate has typically been to provide a higher yielding source income while keeping with inflation so that when an investor is ready to leave the market they have an asset that has appreciated with the value of the dollar.
Today with interest and dividend yields being so depressed from the “easy money” position of central banks around the world. Investing in real estate has become popular again, even with the crash in 2008 so fresh on investors minds.
For decades, whenever mortgage rates have fallen this had signaled to home buyers an opportunity to buy real estate because of the monthly savings from the reduced rate. Up until the last decade this cattle call of sorts has paid off for homeowners and investors. The situation though, as of late, has changed and these historic low rates may signal a large depreciation in the value of real estate in the coming years. The above statement may ruffle a few feathers since it goes against what we all have been taught and or experienced for most our lives, but lets look at the facts.
We need to accept first and foremost that home buyers primarily consider the monthly payment and then the total cost of the property. Having spent many years in the mortgage finance industry I can tell you from my experience, monthly payment is primary consideration for both the lender and homeowner. So understanding the primary influence on a home buyers decision, consider the following:
January 1983 the average mortgage rate on a 30 year fixed conventional loan were 13.25% with 2.2 points (a point is a percentage of the loan that is due at closing, so for 2.2 points a buyer would have to pay $2,200 at the close of a $100,000 home). Today the average mortgage rate for January 2013 on a 30 year fixed conventional loan is 3.59% with .43 points. According to Lending Tree (November 2012) the average monthly mortgage payment in the United States of America is about $1000.
Considering the above data please review the following. Based on an average rate of 3.59% in January 2013, a monthly mortgage payment of $1000 allows for a mortgage of $220,223.76. Assuming the same mortgage amount in January 1983 with the average interest rate at 13.25%, a $1000 monthly mortgage payment would allow for an $88,827.81 mortgage. If we were to finance the same $220,223.76 at 13.25% our monthly payment would be $2479.22.
So from the above what we should objectively take away that real estate values have not truly tracked inflation as much as they have followed mortgage rates, considering what the $1000 could afford monthly in 1983 and today. From the above it is fair to say that mortgage rates have influenced the value of real estate more than it has paced inflation. One could possibly take away that real estate values have gone down over the past 30 years.
The US Federal Reserve has kept mortgage rates low in the United States by keeping the Fed Funds Rate targeted at 0 to .25% and actually buying mortgage backed securities. This participation in this market is probably the primary reason we are discussing investing in real estate so soon after the real estate debacle several years back.
Consider when an area has a weather emergency, such as a damaging hurricane, would we expect insurance premiums to go up or down? The obvious answer is that premiums go up. It is fair to say that the Federal Reserve and the US Government are artificially supporting the values of Real Estate in the USA since rates should have gone up after the crash rather then down.
From all the above points, we may be able to draw a conclusion that investing in real estate may be a good idea today, but what happen when (NOT IF) rates go back up because of either the Federal Reserve believes we are on a secure recovery and stop supporting them or they lose political backing.
The above article represents the opinion of the author and does NOT imply any type of financial advice.