What a few weeks it has been. In a very short span, we went from a minor health inconvenience to a worldwide pandemic. Italy is attempting to isolate 16 million citizens, and our own government is advising anyone at “risk” (older people and anyone with compromised health) to stay indoors and avoid contact with others. Russia is trying to use the slump to drive out oil shale producers (United States and Canada) and oil prices suffered their biggest one day drop since 1991 after the invasion of Kuwait.
A Falling Stock Market and Interest Rates
The stock market was at an all-time high February 10th just shy of 30,000, and now it sits at 24,000…a 20% decline in 30 days. To keep the economy chugging along, the federal reserve cut rates to 1%, the 10-year treasury slumped to an all-time low of .4% and the 30-year treasury dropped to 1% and the interest rates for a 30-year mortgage may drop to 2.5% shortly (they are currently at 3.5%). What does this mean for the real estate market and property management?
Anyone who can refinance, will. This may be good for the economy in the short term because homeowners may save hundreds of dollars a month on their mortgage, freeing up funds to buy or invest. Others will pull out cash and make home improvements or purchase a vehicle at interest rates we may never see again in our lifetime.
It seems this virus hit at a very inopportune time: the time of year of conventions, vacations, events and public gatherings. The ripple effect of these cancellations will harm the economy in the short term, and once the virus works its way through the general population, we would expect the economy to get back to normal and put this entire messy episode behind us. But it is my opinion that the decision to lower rates to unheard of levels will have a long-term impact on the housing market and property management.
Why Low Rates Can Hurt Housing
Once a homeowner refinances at 3%, and rates move back up to still very historically low rates (say 5%), there is little incentive to move up or out because that would require securing a new mortgage at a higher rate. It is estimated that a drop in 30-year fixed rate mortgage rates of ½% equals a buying power that is 5% higher. For example, if interest rates are 4% and drop to 3.5%, I can buy a home for $550,000 rather than $500,000 and the payment is about the same. That is occurring right now, home prices are moving up as rates go down. But what happens when the opposite happens? If rates go from 3.5% to 5%, prices would have to decrease 15% for a buyer to have the same mortgage. Mark my words: rates will increase after the effects of the virus dissipate, and that will put pressure on home prices to decrease. It has been my experience, owners are loath to reduce their asking price and adjust slowly to a softening real estate market.
In a nutshell, we may avoid a deep recession only to find ourselves in a housing recession shortly after. Also, we may see far fewer sales as rates continue to increase and homeowners prefer to sit on their low interest rate rather than move and not only face a higher mortgage but also higher property taxes. Low interest rates may mitigate this health crisis but may cause long term disruption to the housing market, particularly in California. Ironically, the coronavirus may make our housing market unhealthy in the long term because of these incredibly low rates.
Effects of a Recession on Property Management
If we have a deep recession, tenants may lose jobs and stop paying as agreed. If the housing market slumps with increasing interest rates, sellers may choose to lease, particularly if they have refinanced and have a low cost of ownership, rather than selling at a discount. Also, to protect tenants from the impact of the economic recession, elected officials may leap into action and enact more laws protecting tenants from landlords seeking on time payments and swift evictions. All of this means many owners will decide to hire professional property managers to better protect their investments.
Those are my two cents. This will be my third recession and I hope it pales in comparison to the Great Recession of 2008-2010. Every recession is different, and if the coronavirus is the root cause of this one, no one would have predicted that even two months ago.