For the TL:DR crowd…
We expect mortgage rates to rise through 2017
Tempered by rising mortgage rates, we expect luxury condo prices to increase gently in 2017 (less than 3 percent) in core downtown markets.
Demand outpaces supply in our core markets, particularly for product priced between $1-2M.
Bidding wars will be less prevalent as buyers exhibit increased anxiety related to overpaying.
Cash buyers’ advantage will increase as mortgages become more expensive
Lending restrictions will ease opening up a larger market for 10 percent down buyers
Trump card: The President.
The talk of the town (and the nation) as we closed 2016 centered around the second time in the last decade in which the Federal Reserve raised the short term, inter-bank interest rate. While the spectre of an interest rate increase may strike home buyers (and even sellers) as a negative, it’s important to consider the larger implication of this action - the Fed is signalling that the US economy is relatively healthy and growing.
As wage earners and consumers the insight there is that, whether we feel it or not, we’re likely making more money and, in turn, should have some disposable income to put back into the markets.
Much of the rhetoric around home-buying in an increasing interest rate environment will be focused on affordability - particularly in an expensive market like Boston. The scope of the affordability impact is often difficult for home buyers to get their mind around so let’s use an example to demonstrate how the changes could affect you.
Assume a buyer is taking out a $1 million mortgage to purchase a luxury condo. The below table charts the monthly cost to carry that mortgage at several different interest rates (with dates when those rates were available) along with the overall difference in annual cash expended. Remember, our projection is that mortgage rates will rise throughout 2017.
Date............. Product........... Rate..................Payment per month..............Net (+/-) payment per year
11/3/16........7 year ARM.........2.625%..............$4,016........................................................N/A
12/15/16.......7 year ARM.........3.25%................$4,352....................................................+ $4,032
12/12/17......7 year ARM.........3.625%............$4,561......................................................+ $6,540
*An estimate based on the Fed’s announcement that they expect three more rate increases in 2017
We charted the 7 year ARM because it has been the most popular mortgage product with our clients over the last two years. Keep in mind, the delta in monthly payments is the absolute change in payment (principal plus interest) as opposed to the change for additional interest alone. The chart is intended to show differences in cash flow (which equates better to affordability) as opposed to the difference in interest paid. The mechanics of an amortization schedule are a topic for a different day.
Assuming our hypothetical buyer will need to pay an additional $4-6k per million dollars financed per year to buy in 2017 versus what they paid in 2016, the question becomes is that number big enough to give them pause during a purchase decision? Naturally, this is when the conversation intersects with asset pricing. In other words, can the buyer get what they want for the price they’re willing (or expecting) to pay?
The answers to these questions, respectively, are “no” and “yes.” Pricing in downtown Boston will be held in check (said another way, appreciation will be limited) by increases in mortgage rates in 2017. Our buyer is probably earning around $300,000 and has likely seen a CPI type increase in their wages over the last year (+/- 1.1%) or perhaps $3,000. While they may not run the math themselves, a $200 per month increase is not going to move the needle for them in any material way.
Further, knowing that unemployment in Boston is extremely low (2.8%) should bolster the case that this buyer can (and will) absorb the increase in payments in order to buy such a home. If they don’t, someone else will. Compared against the alternative of paying $4,000+ per month in rent for a comparable quality rental unit, the purchase scenario remains more compelling as long as the buyer is committed to owning for more than two years. It’s also worth noting that mortgage qualifications may be loosed in 2017 as rates increase. Down payments of 10 percent will continue to become more common alleviating some of the pain of a more expensive entry point for buyers.
We’re always thinking about the best ways for buyers to enter the competitive Boston market through creative financing or, better yet, off-market deals. In 2016, our clients were rewarded with many off-market opportunities to consider and continue to see/hear about a lot of these heading into 2017. Let us know if you have a requirement (to buy or sell) in the coming year and we’ll keep you on our list to see if we can find the perfect match.