Rising Mortgage Rates? Time for the Crystal Ball [Analyze This]

by Osman Parvez
Last week, the Fed released January's FOMC minutes, reaffirming a 2% inflation target and expectation to make gradual increases in the federal funds rate.  

Here's the critical verbiage:

"Members expected that economic conditions would evolve in a manner that would warrant further gradual increases in the federal funds rate. They judged that a gradual approach to raising the target range would sustain the economic expansion and balance the risks to the outlook for inflation and unemployment. Members agreed that the strengthening in the near-term economic outlook increased the likelihood that a gradual upward trajectory of the federal funds rate would be appropriate. They therefore agreed to update the characterization of their expectation for the evolution of the federal funds rate in the postmeeting statement to point to "further gradual increases" while maintaining the target range at the current meeting. Members continued to anticipate that the federal funds rate would likely remain, for some time, below levels that were expected to prevail in the longer run. Nonetheless, they again stated that the actual path for the federal funds rate would depend on the economic outlook as informed by the incoming data."


What does this mean for Boulder real estate?  Let's get out the crystal ball.  

- Current mortgage rates are already up significantly, from 3.8% last September to 4.4% today. 60 basis points results in a 7.5% increase in the monthly payment for a 30 year, fixed rate mortgage. That's a big deal, but it's not felt equally across the market. 

- The effect of rising rates should cool demand at the entry and mid-range of the market, where buyers are more focused on  monthly payments. It also dampens cash flow for income properties. At the higher end, luxury home purchases are often funded by liquidating equity or other assets. These buyers pay cash and often lever the asset after closing. They're far less sensitive to monthly payments, especially if higher yield options exist for the capital.    

- The entry and mid-range of the market are the most active segments in Boulder real estate, where demand outstrips supply by a large margin. During the last several years, even a dilapidated entry level ranch in south Boulder would often attract several offers.  Updated ranches, those with a finished basement, on a larger than typical lot, or situated on a quiet street  in particular. The rate of appreciation for entry and mid-range homes should now flatten as the Fed ratches up interest rates.  This should increase supply, which is a welcome change.

- It's important to note that while the Fed funds rate is the benchmark for all interest rates, how it shakes out to mortgage rates is dependent on market factors.  Another key to consider is the impact of the Fed gradually unwinding it's balance sheet.  Will the market continue to absorb treasuries and collateralized mortgage products? If not, it could act as fuel on the fire for even more rate increases, required as needed to attract investors.  Unleashing the inflation genie is a big risk for the economy. 

- How to invest in an increasing inflationary environment is a problem not seen for many, many years.  Institutional investors across the spectrum are grappling with it.  

- Historically, real estate is a classic inflation hedge.  Buying a large, leveraged asset at a locked-in fixed rate means the asset value will float while your payments remain the same.  When I asked one of my first real estate mentors about purchasing his first home in the 70's hyper inflationary period, he told me he didn't care because his income growth outpaced all of his other costs. Locking in a house payment was a great thing at the time, even when rates were at 15%.  

- Although prices seem high today, they may continue to increase in nominal terms.  If you've been sitting on the sidelines renting, you may want to get off the bench now.  If you're planning to stay in the community for at least three years, buying almost always beats out renting from a financial perspective - even in a relatively flat market. 

- If you're considering investing in real estate or would like to sell a real estate asset you already own, don't hesitate to reach out to us.  As Realtors, we're a little different from our competition. From helping you understand market conditions, to advising you on property selection, to offering expert negotiation advice - our goal is to help you make a smarter real estate decision. 

Want to get blog updates via email?  Click HERE.       
Ready to buy or sell?  Schedule an appointment or call 303.746.6896. 
You can also like our Facebook page or follow us on Twitter.

As always, your referrals are deeply appreciated.  

The ideas and strategies described in this blog are the opinion of the writer and subject to business, economic, and competitive uncertainties.   We strongly recommend conducting rigorous due diligence and obtaining professional advice before buying or selling real estate. 

image: David Zawila

Please Note

This document contains forward-looking statements. You are strongly cautioned that investment results are subject to business, economic and other uncertainties. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time. Always consult your financial advisor before making an investment decision.