Mortgage rates for a 30-year mortgage bottomed our around 3.4% in July of July of 2016. Rates recently broke through the 5% mark and the 10-year treasury just hit a 7-year high. At the same time Well’s Fargo announced it was laying off over 600 mortgage workers and many other banks have followed suit. What is the market telling us? Is Denver a harbinger of what is to come? Is the market overreacting to the rising rates? Do you think 5% is the “magic number” or is it something higher?
Why are rates rising?
30-year mortgage rates follow closely with longer term treasuries (10-year). The federal reserve has been raising short term overnight rates at a faster pace than the market anticipated. This has caused longer term yields to increase. This increase in longer term yields has led to the recent “jump” in mortgage rates.
Why is the fed raising rates?
The federal reserves job is to help not only fight inflation but “smooth” out economic cycles. Currently inflation has been non-existent as wages have basically stagnated. The federal reserve is instead focusing on smoothing out the economic cycle. It appears that the federal reserve continues to raise rates to ensure that they have room to drop rates when the next economic cycle hits which most economist are saying is around 2020.
Stagnating wages:
Wages are basically “stuck” with little upward movement for most workers. As wage growth has been tepid, any increase in rates can’t be “absorbed”. If workers aren’t making more, how are they going to pay a higher mortgage? At some point the math doesn’t work with current wages.
Is 5% the magic number?
By historical standards, a 5% mortgage rate is still a great rate, but the market has gotten accustomed to lower rates over the last 8 years. Now is the first time in about 8 years that rates have crossed the 5% threshold (Freddie Mac). The prior low rates have allowed people to afford more than they could in the past. The recent increase in rates will have a profound impact on purchases, refinancing, and the commercial market. This leads us to the question, is 5% the tipping point in real estate?
Is Denver a Harbinger on purchases?
In Denver, sales of homes worth 1 million or more fell 44.4% between August and September and sales of homes over $500,000 dropped 33 percent during the same period. Overall sales in September of 2018 are down 21.4% from September 2017 (Colorado Hard Money). This is due in large part to the increase in mortgage rates.
Denver, like many expensive markets, will feel the effects quicker than other markets as the median home price is higher. As a result, the average loan size is also bigger so each move in rates will impact borrowers more. Denver’s recent slow down in purchases will eventually hit other less expensive markets as rates continue to rise.
Refinancing
Not only are sales slowing because of rates, refinancing activity is down considerably. In the past, consumers utilized a refinance to lower their monthly payments and or pull cash out. This has all but dried up.
Refinance volume, which is highly rate-sensitive, fell 6 percent for the week and was 39 percent lower than a year ago. “As mortgage rates increased to a five-week high, the refinance index decreased to its lowest level since the end of 2000,” said Joel Kan, MBA’s associate vice president of economic and industry forecasting (CNBC)
Commercial Properties
Not only are commercial property interest rates also rising but commercial property values are being impacted by the raise in rates. Interest rates and capitalization rates typically move in lockstep. So higher rates mean higher capitalization rates. In 2016 the 10-year treasury was 1.4%, the current cap rate is 3.2%. For example, if a property traded on a 3 cap in 2016 when rates were at there lowest, with the newest move in treasury rates that new cap rate will be closer to 4.8%. The value of the property will be substantially reduced, fortunately in a rising economy rents are also increasing, but not fast enough to compensate for the quick rise in rates. Remember capitalization rates and values move in inverse so the higher the cap rate, the lower the value. This has huge implications on commercial real estate values.
What does this mean for the market?
Rates above 5% have exceeded every major prediction for 2018. The average consensus going into the year would be rates around 4.5%. This steep run up in rates has caused a “knee jerk” reaction from the market. Based on the steep fall in purchase transactions at certain price points, the large drop in refinancing, and the impacts on commercial properties, is crossing the 5% threshold telling us something more about the economy? Although it appears 5% is a “threshold” for the real estate market that has had profound impacts, it doesn’t appear that 5% is a “trigger” for a market crash. The market is starting to adjust to the higher rates which has led to the slowdown in purchase and refinance transactions. As the markets adjust to the new normal, I think there will be a cooling of purchase and refinance activity, but I don’t see this as an indicator that the real estate market will tank.
What is on the horizon?
How mortgage rates (and treasuries) rise in the future is the million-dollar question. Currently the 10-year treasury rate is around 3.2%, several economists have predicted the 10-year treasury will move above 4% in 2019. If they are correct this would put mortgage rates north of 6%. Is 6% the threshold for the real estate market? Unfortunately, nobody knows exactly what the magic number is that will tip the scales and drastically alter the real estate market. My bet is that a 6% rate, which is almost double what the rate was a few years ago, will be the tipping point for the market. What do you think? What is the “tipping” point that will cause the real estate market to enter the next cycle?
Resources/Additional Reading
- https://www.housingwire.com/articles/46571-wells-fargo-to-lay-off-638-mortgage-lending-employees
- https://www.cnbc.com/2018/09/12/weekly-refinance-demand-plummets-as-mortgage-rates-hit-a-5-week-high.html
- http://www.freddiemac.com/pmms/pmms30.html
- https://themortgagereports.com/32667/mortgage-rates-forecast-fha-va-usda-conventional
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).