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This post was updated Oct. 23, 2023.
After the Fed’s hike in interest rates to stem inflation, buyers are backing out of the real estate market in increasing numbers.
Adding to the maelstrom is the current volatility in the stock market, creating a double whammy for some buyers who are not only encountering higher mortgage rates but are seeing potential down payments devastated as declining stock prices are lowering portfolio values and undermining stock options.
Some buyers are taking a wait-and-see posture, hoping that rising rates will reduce home prices enough that they can regain a foothold in the market. Others, sensing blood in the water, are circling like sharks hoping to pick off bargains from desperate sellers who are stuck on the market longer than anticipated.
Regardless of the rationale, the number of buyers out looking has dramatically decreased as evidenced by a decline in the number of multiple offers, decreases in the numbers tramping through open houses and a noticeable drop in buyer leads from all sources.
There is significant money to be made in a shift by those who understand the factors behind the market and respond accordingly. Here are six responses buyers will give in the emerging market along with our recommendations on how to counteract them.
‘I’m going to wait for lower interest rates.’
For those buyer wannabes who have been looking at mortgage rates the past couple of years, the 200 basis point jump over the same period last year is a severe shock. Although understandable that buyers might want to wait until lower rates appear, this logic reveals a lack of understanding about how we ended up with low rates to begin with.
Those in this business for a long time have seen much higher rates. Freddie Mac began tracking mortgage rate information in 1971 and, if you calculate the average rate since then, it comes in at a whisker under 8 percent. Many current millennial buyers have never seen high rates and not only lack a historical perspective, but they also do not understand the factors facilitating the record low rates of the past few years.
Due to the economic collapse in the mid-2000s, the Fed, attempting to revitalize the economy, began slashing interest rates, with the average rate in 2009 winding down to 5.4 percent. Due to the low rates provided to lending institutions, mortgages dropped to an average of 3.65 percent in 2016.
As the economy once again screeched to a halt, this time due to the global pandemic, the Fed further loosened rates and mortgages dipped as low as 2.68 percent at the end of 2019. 2020 saw an incremental rise to an average of 3.11 percent.
Although understandable that buyers want continued low-interest rates, we all hope that the primary conditions that produced those rates — a total global economic collapse and subsequent global pandemic — will not be returning any time soon. With a more normalized economy, rates will head upward and most likely return to historic averages over the next few years.
Bottom line: Those who are waiting for a return of rates such as we have seen the past few years might end up waiting decades.
In fact, the short-term prognosis is for rates to rise even further as the Fed continues putting the brakes on the economy. Buyers who are on the fence waiting for rates to come down should be counseled to lock in rates sooner rather than later.
‘I’m going to wait for prices to come down.’
To begin, even if home prices fall, it is projected that, due to low inventory, the declines will not be significant enough to offset the projected increases in interest rates. At the end of the day, the most important number is not the purchase price of any home, but the amount of the monthly mortgage payment.
Second, while this excuse appears logical on the surface, it displays a lack of understanding of the overarching issues surrounding homeownership, which is, for most, the single largest investment they own and the largest contributor to their wealth.
As an example, between Jan. 1 and April 30, 2021, homes in our region increased in value an average of 28 percent. In just four months, homeowners with a home valued at $500,000 saw a passive increase in their wealth of $140,000.
During this same period, as home values increased, rents went up, as well. Those who owned homes saw a dramatic increase in their wealth, while those who were renting, due to rent increases, saw their net worth decrease. Although this was an extreme example, it highlights the reason homeowners, on average, have a net worth 40 times greater than the average renter, according to a survey by the Federal Reserve.
Third, those who own homes in the United States have tremendous tax advantages. Although numerous attempts have been made to eliminate the homeowner’s mortgage interest deduction, the deduction remains and further enables homeowners to build wealth while those renting have no such opportunity.
Fourth, as the stock market continues its seesaw behavior, real estate has long been considered the safest and most beneficial long-term investment. While some have made short-term money in the housing market through flips and other such investments, most investors make their money by buying and holding.
One of the lessons learned during the financial collapse in the mid-2000s was that homeowners cannot treat their homes like an ATMs. Those who made it through the crisis intact were the ones who did not speculate on the market but instead, hunkered down for the long haul. Although home values plummeted during the collapse, the market rallied, and current values are substantially higher.
The lesson here is simple: The purchase price does not matter if the strategy is to buy and hold. The only thing that does matter is the ability of the owner to service the monthly mortgage payment.
The goal is simply to own the roof over your head, not speculate on the home’s potential value. Given enough time, history has more than amply demonstrated that those who buy and hold come out much further ahead than those who try to time the market.
‘I’m going to start writing lowball offers.’
Our advice to these buyers is simply, “Knock yourself out.” Although true that there are some sellers who must sell and do so quickly, most sellers understand that we are in a shift and that if they wait a bit longer, they can expect to receive a reasonable offer on their home.
At this juncture, all lowball offers tend to do is alienate sellers and frustrate the buyer’s agent who has to write the ridiculous offers.
‘I’m going to sit it out with my rental.’
All fine and good, but there are some very important facts renters need to know about the long-term future they face as tenants.
First, as demonstrated above, the choice to continue to rent robs individuals of the potential to begin building wealth through homeownership.
Second, as the costs to landlords increase with higher mortgage rates coupled with increasing labor and maintenance costs, you can count on rental prices increasing over the next few years just to keep current with the increases in operating costs. Additionally, increasing values have also boosted property taxes and landlords will be looking to tenants to offset these additional costs.
Third, many rents have failed to track with the rampant increases in property values over the past few years, and landlords are now looking to raise rates to parity. In locations that have seen the most significant increases, you can expect rents to skyrocket over the next few years.
Fourth, some landlords, due to the incredible increases in value, are looking to cash in and redistribute their gains. This means they will be looking to sell and either exchange the properties or simply cash in and get out of the rental business altogether.
As mentioned in the previous paragraph, because many rents have not kept track with increased values, the first priority of any new owner is to get the property performing at equitable levels. Translated, this means increased rents.
To those who insist they are going to sit tight in their rentals, our response is, “Good luck with that.”
‘I can’t afford to buy the home I want.’
As a child, I shared bedrooms with my siblings until my parents could afford a larger home. We also did not have a family room, separate living or dining rooms nor did we have a large yard. We did not live in the best neighborhoods or attend the highest-rated schools. Personally, I think I turned out OK.
Today’s buyers have, in many cases, totally unrealistic expectations that are keeping them from making prudent financial decisions. They forget that the goal is to get into the market, not necessarily get the ultimate home they want right off the bat.
They also think they need to drive a new car, take expensive vacations, own an 85-inch TV, designer clothes and so on. I suggest frank conversations centered around making wise financial decisions and recommend they start listening to sound financial advice from sources such as Dave Ramsey.
‘I can’t afford to buy in my local market.’
Our advice to these buyers is to seek out an area of the country where they can afford to buy and purchase a rental. There are many tax benefits available to those who invest in real estate and, rather than sit tight and do nothing, we recommend they at least get in the market somewhere.
There is no question that rising interest rates have pushed us into a market shift. Wise investors understand that there is significant money to be made during a shift by those who understand the potential gains and jump into the market instead of sitting it out on the sidelines.
With effective counseling, your buyers will look back years down the road and be thankful they listened to your advice to get into the market now.
Carl Medford is CEO of The Medford Team.
