Implications of a disastrous monetary policy. (Part 1 of 2)
How would your life change if rent prices doubled next year?
The Federal Reserve (The Fed) makes monetary decisions that affect all of us by way of our purchasing power, and there is no escaping it. Any smart investor tries to predict future market trends to get an edge on the rest of the herd. Herein, I will help you do just that within the rental housing industry. Whether you’re a landlord or you rent your house, you will be affected!
If you’re a landlord, you’re in the business of making money. If you’re a renter, you probably want to save money to buy a house. If you don’t care about extra money, maybe you’ve found the wrong blog?
A huge announcement was made this past week, and it will surely affect your future. If you missed it, The Federal Reserve surprised almost all economists with their announcement:
“The Federal Reserve did something completely unpredicted on Wednesday; nothing. So called “tapering” of QE (quantitative Easing) was indefinitely placed in deep freeze……”
Basically, this means that The Fed feels the need to keep artificially boosting the economy (read: by printing money and inflating the currency supply) by buying an array of United States debts. These include treasury bonds, and mortgage backed securities. Definitions for some applicable terms can be found at the bottom.
So, what does this mean for rental housing? To answer this accurately, we need to first look at interest rates on mortgages. You should know that The Fed sets current short-term interest rates, which the market interprets to set long-term interest rates.
“The Fed currently purchases $40 billion in mortgage backed securities and $45 billion in treasuries each month… This artificial demand for mortgages and U.S. Treasuries by all means is the lynchpin to keeping rates low.”
Low interest rates on mortgages can be a big incentive for an individual to buy a house: either for themselves or with the purpose of renting (and thus becoming a landlord).
For example: On a $200,000 mortgage at today’s 30-year fixed rate of 4.37%, the monthly payment would be $997.98.
On the contrary, lets revisit the high interest rates of the 1980’s: 18%! The same $200,000 mortgage at a fixed 30-year rate of 18% would now cost you $3,014.17 per month!!!
That is over a $2,000 difference with nothing more than the interest rate changing!
Do you interest rates matter when purchasing a home? Absolutely.
Do low interest rates encourage home ownership? Absolutely.
Do we have historically low interest rates today? Absolutely. (Rates in the 4% range were unheard of until 2010)
Can interest rates remain this low indefinitely? Absolutely NOT!
How have low interest rates from 2010 until now affected the housing market? According to contributor to Forbes magazine, Mr. Richard Finger:
“The low mortgage rates have indeed spurred the housing market. But that too is to some extent artificial. There are still various mortgage programs, like FHA, (Federal Housing Administration) where only a 3 percent down payment is required. Fannie Mae has a three percent down offering as well. FHA standards have been so lax and defaults so high that the agency is now basically bankrupt…. Has anyone considered that if there are real buyers out there, with a real cash to make meaningful down payments then a hundred basis point (one percent) increase in rates shouldn’t matter very much? Maybe the price of some houses would come down to compensate for the higher rates. There are so many asterisks next to the housing recovery I wonder where the truth really lies.”
Mr. Finger seems to agree that low interest rates have helped boost sales in the housing market. There are only so many houses and apartments in existence, and if more Americans buy, then less rent. Thus, a boost in sales in the housing market has in kept downward pressure on rental prices. There are exceptions however, like in NYC and San Francisco, but those are anomalies with many external factors like the Tech boom.
Average rent prices aren’t cheap (as I know first-hand) but would be more expensive with a less active housing market. Higher interest rates would almost definitely slow home sales, putting more demand back into the rental housing market.
Supply and demand- the first principle of economics- tells us that less supply equals more demand.
Less Americans buying their homes = more Americans moving into rental housing.
More demand for rental housing = less supply.
Less rental housing supply = higher rental housing prices
Fear not. The good news is in the near term, there’s no indication that the Fed’s announcement should significantly affect the rental housing market. The bad news: speculating on the rental market is a job better suited for an economist.
In part 2 of this installment, I will speak with the author of the Forbes piece referenced above, Mr. Richard Finger to gain his expert insights about implications of The Fed.
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Federal reserve http://en.wikipedia.org/wiki/Federal_Reserve_System
Quantitative easing http://en.wikipedia.org/wiki/Quantitative_easing
Interest rates http://en.wikipedia.org/wiki/Interest_rate
Mortgage backed securities http://en.wikipedia.org/wiki/Mortgage-backed_security