In September, the Federal Open Markets Committee, the Fed’s policy setting arm, decided not to raise its benchmark rate, which has been near zero for seven years. The benchmark rate is what a central bank issues which other interest rates are calculated against. Also called base interest rate, it is the minimum interest rate investors will demand for investing in a non-Treasury security.
Ahead of the meeting and even after, there had been little certainty about what the Fed would do, but a good number of analysts believed that the economy had improved enough to compel the Fed to raise rates. It turns out that rates are not going up anytime soon. Why?
In a word, September’s employment numbers were ugly. Only 142,000 jobs were added, which is well below the average for the year (approximately 200,000), plus we lost more than 59,000 jobs in revisions to past months. Historically, August sees the biggest upward revisions of any month on the numbers reported, so the report was extremely disappointing. Additionally, 350,000 workers left the labor force and wages dropped during the month. I think this ends any possibility of the Fed raising rates later this month or potentially this year.
The most depressing statistic in the report is that labor force participation rate — the fraction of all Americans over 16 who are working (as opposed to unemployed or simply not looking for work) — is the lowest it’s been since 1977. The falling participation rate is a long-term trend during the last 10 years. Some of it is due to slow business growth. And some is simply due to Baby Boomer retirement and young adults staying in school longer. But the bigger factor is the lack of strong well paying job prospects. As stated before, the lack of wage improvement over the last ten years is nonexistent.
At the same time, though, there are still a higher-than-normal percentage of people who are underemployed — an indication that the US still needs millions more jobs.
What does this mean to you and your clients? At this point it looks like rates won’t be raised until mid-2016 at the earliest, so now is a great time to buy to lock in low interest rates.
Regionally, commercial and residential property sectors continue to perform well, particularly in our Texas metros. This extended period of low interest rates probably won’t be seen again in our lifetime. The good news is that low rates and high demand continue to drive property appreciation. If anything it puts more pressure on finding the right opportunity for clients with the knowledge that values and rates will rise over the next year.
Regional job growth continues, generating new commercial space demand that dramatically outpaces construction levels, and vacancy in the primary property segments remains on track to decline this year and support additional rent gains across the region. Apartment construction has slowed in our metros, but favorable demographic trends and challenging conditions for first-time homebuyers will continue to sustain extremely low vacancy in the multifamily sector.
The potential move away from zero interest rate policy, for short-term rates, is a harbinger of higher mortgage rates ahead and the beginning of the end of this seven-year era of incredibly low mortgage rates and corresponding high affordability. It will be a shock to many homebuyers under the age of 35. Forecasts for mortgage rates vary, but indicate a potential increase of 50 basis points over the next 12 months.
A 50 basis point ( ½ point) increase in the effective mortgage rate could result in the following outcomes:
- A 6% increase in monthly payments on new mortgages.Nationally the average 30-year fixed mortgage was $231,000, with a monthly principal and interest payment of $1,107 at the average interest rate of 4.03%. When rates reach 4.53%, that same loan amount would result in a monthly payment of $1,175, an increase of 6%.
- As much as 7% rejection of mortgage applications. The increase in the monthly debt burden as a result of higher rates will stress the upper limits of loan- and debt-to-income ratios for new loan applicants.
- Average debt-to-income ratio to increase by 4%.The average debt-to-income ratio for mortgages in the first half of 2015 was 35.5%. With an increase of mortgage rates by 50 basis points and keeping all other factors equal, the average debt-to-income ratio increases by 4% to 37%.
- Popularity of loan types will likely shift with rate increases.In the first half of this year, conventional mortgages were most popular, capturing 50% of the market, followed by 31% FHA, and 12% VA. Under the modeled higher rate scenario, conventional and jumbo mortgages were most likely to hit an upper limit on debt-to-income ratios, and VA and FHA loans were least likely to hit an upper limit.
- All of this is based on values remaining stable. In this region we have been blessed with continued appreciation. So the buyer that waits loses potential appreciation.
- Conclusion: today’s buyer can afford ~6% more home than when rates do rise.
The effect on demand won’t be so much on volume as on housing type. If and when there is a rate hike, the most common response from buyers will be to lower their price range. So don’t expect to see a big impact on demand, but that demand will be slightly redirected toward lower priced homes.
Secondly, as stated above Texas has great opportunity with continued demand for investment properties that show strong return. With rates this low and healthy demand, opportunity for better returns in our region versus other parts of the country is obvious.
The good news in this region is we have not had over stimulated appreciation as other parts of the country have had or what the market saw before the financial meltdown. Sure, Texas has had a good run for the last few years with 8.12% appreciation last year, but only 25.99% over the last 5 years or 139% since 1991.
When you compare the Texas region to the rest of the country over time, you can see that regional appreciation has been slower than much of the country. At times in the last ten years, the Texas Region has been the lowest in annual appreciation.
The point is that metros in Texas continue to be attractive compared to the rest of the nation. The healthy slower appreciation coupled with lower rates present tremendous opportunity for those comparing risks for real estate and financing in other parts of the country.
If you are thinking about buying, you have been given a reprieve for another six months or so as rates stay at the second lowest they have been in the last hundred years. Most buyers believe rates will rise soon, and today’s low rates are a key driver motivating people in the market to buy now.