My wife and I recently moved to Annapolis. A few people have asked me why we’re renting and not buying a place with interest rates as low as they are. Crazy, right!? I’m not sure if it’s a gift or a curse but I look at everything from an investment perspective, so allow me to give my view on real estate right now.
So why are interest and mortgage rates so low? It has to do with the deflationary pressures that de-leveraging has on the economy, including falling asset prices. The Federal Reserve knows that people do not want to take the risk of borrowing money (for anything really, but we’re focusing on buying a home) during a bad economy with falling housing prices. So, the Fed is trying to incentivize you to borrow money for a mortgage by lowering interest rates to hopefully create activity in the housing sector.
But why does the Fed need to incentivize people to borrow money? I believe the answer is two-fold. First, they know that housing prices will not be rising for some time. Secondly, the housing sector is the largest contributor to US GDP. An inactive housing sector means high unemployment and low production. Without rising prices to pull in people, the Fed will have to incentivize activity.
Now let’s look at a few reasons why I’m willing “to pay someone else’s mortgage.”
- I don’t think housing prices will be rising for at least 8-10 years. History tells us that it takes a long time before an asset will begin to appreciate after a bubble bursts (it largely has to do with oversupply and broken psychology).
- The US simply does not have the demographics to support housing demand with a shrinking working class each year. There aren’t too many Baby Boomer’s looking to upgrade from renting to buying right now…
- A report earlier this year by Zillow estimates that there are nearly 16 million homeowners (31.4% of all homeowners) underwater, which means they’re frozen in place
- Credit expansion, as discussed in painful detail by famed Australian economist Steve Keen, is the key determinant of housing appreciation. This is probably the most significant point. Unfortunately, those that are able to borrow don’t need to, and those that want to borrow cannot because of credit restrictions… no credit expansion, no price appreciation
- Inflation (ex-energy and food) is pretty darn low right now, meaning I would be borrowing at a real rate of positive 3% to 3.5%
- Real Estate is extremely illiquid and expensive to buy/sell
- It’s extremely difficult to hedge the value of your home, meaning the return on your investment is subject to market risk and out of your control
- No real estate taxes
- No maintenance and repair costs: no windows and roofs to replace and no yard to cut
To sum it up, interest rates are low as compared to 20 or 30 years ago, but it’s all relative to inflation. Once inflation rears its beautiful head (beautiful to the holder of a large debt), credit terms loosen and demographics are in place to support rising asset prices, I’ll then lock in a nice, big, fixed rate mortgage. Until then, I’m plenty satisfied to rent.