The past two years have been a crazy ride for home buyers and real estate investors. National real estate prices have gone up 45% since January 2020 according to the S&P/Case-Shiller U.S. National Home Price Index. To put that into perspective, a new home would have cost you $214,000 in January 2020, but $304,000 today. This price appreciation has been a great benefit for anyone owning property through the rise, but not so much for those looking to purchase their first investment or primary residence.
With the meteoric rise we've seen in prices recently, one can't help but wonder how long such a dramatic rate of increasing prices could reasonably persist. While real estate prices have historically trended up and to the right over longer periods of times, it's reasonable to have some suspicions about deploying a lot of cash into the real estate market at such a volatile (to the upside) time.
There are two great and basic indicators that I use to think about whether I should let off the gas or go pedal to the metal with my real estate business. It is not so much of an on/off switch as it is a dial that helps me think about whether I'm heavily buying or buying slightly less. I do believe that a deal can be made in any market, but sometimes it might require you to pivot strategies based on what the market is telling you. Housing is a human need that will never go away, and therefore there will always be a strong demand element. That being said, there are clearly better and worse times to invest heavily.
30-Year Mortgage Rate
The first indicator that I like to follow is the 30-year mortgage rate. This rate tells you how expensive buying a home will be for the average individual. As mortgage rates increase it dramatically adjusts the purchasing power of the average homebuyer. Here's a chart demonstrating how higher rates affect a buyer's ability to borrow:
| 2.75% | 6.25% | |
| $2,000 Monthly Payment Gets You A Home Worth: | $490,000 | $325,000 |
With rates rising from 2.75% to 6.25%, keeping a $2,000 monthly payment effectively reduces the purchasing power of a homebuyers by 34%. The plain and simple fact is that people are going to be able to afford less when buying a home. How that will affect real estate prices over the long term remains to be seen, but it's a big change nonetheless.
Federal Funds Effective Interest Rate
The second indicator that I like to follow is the federal funds effective interest rate, which is the target interest rate range set by the Federal Open Market Committee. The rate sets the interest for commercial banks to borrow and lend excess reserves, and this rate generally flows down to other markets, such as mortgage, auto, and business loans.
To combat the economic calamity caused by COVID-19, the Federal Reserve dropped the effective federal funds interest rate to effectively 0%. To the Federal Reserve's surprise, that caused inflation to go out of control and the Federal Reserve has now been raising the federal funds effective interest rate to slow down the economy. There's no indication that they'll slow down the rate raises at this time or in the near future, so we can reasonably expect this trend of rising rates to continue.
Why Is This Important?
The cost of money is determined by the Federal Reserve and that has dramatic impacts on what it means to be a real estate investor. If we expect for mortgage rates to continue to go up, while considering the purchasing power that's already been eroded by prior rate hikes, it would be a reasonable conclusion that higher rates would further decrease a borrower's purchasing power. While we haven't seen any material impact on real estate prices yet, it could be on the horizon.
There are many forces affecting the real estate market and prices. While there are a lot of great resources and indicators to analyze, it is extremely difficult (if not impossible) to know for certain which forces will have the most prevailing impact on future prices. The best strategy, which has consistently been proven to work over time, is to buy value, maintain strong cash flow, and have plenty of reserves.
Be a critical investor.
Let's kick the 9-5.
