As this month brought word that the Federal Reserve had lifted the benchmark federal funds rate by a quarter of a percent, the doom-and-gloom scenarios began spinning in real estate offices across the country. If the real estate industry has benefitted from record low interest rates, then rising rates will depress the industry, right? Well, the answer might not be so simple.
As this month brought word that the Federal Reserve had lifted the benchmark federal funds rate by a quarter of a percent — and would follow with additional increases later in 2018 and throughout 2019 and 2020 — the doom-and-gloom scenarios began spinning in real estate offices across the country.
After all, if the real estate industry has benefitted from record low interest rates, it stands to reason that rising rates will depress the industry, right? Well, the answer might not be so simple.
Ray Sturm, co-founder and CEO of San Francisco-based real estate investment firm AlphaFlow, says that the connection between Fed decisions and the mortgage market might not be as cut and dried as we all assume, and in some markets, it might not matter at all.
“People’s gut reaction tends to be that this will slow down housing markets because they’ll become too expensive,” Sturm said. “In reality, it can spur action in the short term because buyers assume it’s going to go higher. When things like this happen, people who were thinking about buying a house get spurred into action. They hear from the agent or mortgage lender, and it gets them to move more quickly so they can buy before the next rise.”
Sturm sees an exception to the assumed cause-and-effect relationship between interest rates and real estate markets in high-demand markets like Manhattan, San Francisco and some other desirable cities.
“General rules go out the window when you are talking about markets like San Francisco,” Sturm said. “We just had a small home down the street go for $9.6 million — 20 percent over asking price. The average home price in San Francisco is $1.6 million. Families making $117,000 qualify for subsidized housing in San Francisco. We live in a weird bubble here where the rules don’t apply.”
While Sturm sees the short-term effect of the interest rate rise as generally positive for most real estate markets, long-term additional rises in 2019 and 2020 mean that over time, that spur buying will die out.
“The market adjusts, and people get used to it, but there will be people who, if they don’t buy now, will have to put it off longer because of these rises,” he said.
One of the things that seems unusual about the current rise in the rate is that it signals confidence in the economy — indeed Fed Chairman Jerome Powell has talked about how great the economy is — and is accompanied by record low unemployment.
Yet the rate of increase in salaries has remained stagnant for the most part. I asked Sturm about what appears to be a fundamental disconnect between salaries and the overall economy and what that might mean for the real estate markets.
“I think what you’ve started to see emerge in the last few years is a disconnect between owners and workers. The Dow is hitting record levels, but you have many people who don’t even own one share of stock. The purpose of these little incremental rate increases is to fight inflation, but without wages moving, you don’t have that same danger of inflation,” Sturm said.
Because people are spending a higher percentage of their income on housing than they ever have, some of the old rules don’t apply, he continued. Historical and macro trends are not necessarily as applicable.
When asked what long-term impact this disconnect could have on the housing market, Sturm said, “When you look at the numbers and the incentives, you’ve created a system where many homes are more valuable to an investor than to an owner-occupied homeowner. If you see a continuation of the same tax policy and continued wage stagnation, I see a trend toward more renters and less ownership.”