iq business

'Safe as Houses' Meets ZIRP

Posted by on in Uncategorized
  • Font size: Larger Smaller
  • Hits: 18187
  • 0 Comments

 

In the US it has practically been gospel for the past 30 years that home buying was a path to wealth. This is indeed the case if one buys a property and keeps it until at least 50% of the mortgage is paid (roughly 2/3rds of the term of a mortgage) and the home does not drastically decline in value in this period. However, in the US, the average homeowner moves every 7 years, when an average mortgage balance has declined by a mere 10%, barely offsetting closing costs. So for better or worse, US homeowners are betting on price gains. For the past 30 years, they have been right.
The nominal changes in homes in the US for Fannie Mae mortgages has gone from $43k in 1977 to $164k by the end of 2011. 300% returns for homes in all brackets are the norm in this period. So what has caused this huge rise in home prices?

Inflation – Inflation colors the value of everything. If we look at the real rate of change in this same period, we see an 18% change over 35 years – 0.5%/yr. This is consistent with study by Robert Shiller of Yale. He looked at urban Amsterdam property prices 1604-2004, and found a 0.4% real rate of return. This period began before the great Dutch Tulip Craze, so is not some sort of cherry picked time series. Amsterdam is about as ideal as one could hope for, and with the canals, makes it difficult for new properties to be added to supply. Even with these constraints, real appreciation is quite muted. So expecting one's home to appreciate at anything faster than the published rate of inflation is to do battle w/ hundreds of years of history.

Recent Mortgage Rates - By the early 80s, mortgage rates were 16%, and have steadily declined to 4% now. What impact has this had on home prices? Well it most certainly has caused them to rise. If we assume that a home buyer in 1977 put down 10%, then at 9% for a $100k home, the buyer would be paying $718/month. If he were paying today's rate of 4%, his $718/month would get him a home of $166k. If he paid the average in this period of 7.3%, $718/month would get him a $105k home. So while home prices have increased 18% over 35 years in real terms, the fall in mortgage rates accounts for 66% ie in a constant rate environment, real home prices have actually fallen. If we imagine that it is within the realm of possibilities for rates to return to the average of 7.3%, then today's home could conceivably lose 35%, just on interest rate changes alone.


Given the enormous overhang of liabilities everywhere in the world coupled with high levels of debt, it is not unrealistic to expect higher interest rates brought about by currency printing and deleveraging. The impact of this on home prices worldwide could be profound.

Rate this blog entry:
1
Trackback URL for this blog entry.

Comments

Leave your comment

Guest Tuesday, 31 March 2020