The Rodney Dangerfield of real estate markets.
If markets could talk, this one would use Rodney Dangerfield's signature tagline, "I can't get no respect".
Yes, as real estate sets new records, skeptics wonder whether this market is anything more than smoke and mirrors. To them, ultra-affordable mortgages are just an illegitimate manipulation of the market. Apparently it doesn't count unless home sales are fueled by 1990s-style irrational exuberance.
Allan Greenspan must be tearing out what hair he has. Since when are interest rates—low or high—not a legitimate market mover? If rates were 18 percent, as they were in the early 1980s, the skeptics would be saying that this isn't a good time to buy. So why aren't they saying it is a good time to buy when interest rates are 6 percent?
Aside from looking a gift horse in the mouth, the skeptics miss a paradox: low interest rates have made money cheaper, but they haven't made home-buying easier. Low rates have turned home-buying into a high-stakes sprint, with the trophy the keys to the house. Buyers trying to win the race risk paying too much. But risk-takers cross the finish line first, while the risk-averse stumble in the starting blocks.
Tired of competing, the risk-averse take another risk: passing up a once-in-a-generation opportunity. "I'll wait until higher rates take my competition out of the market. Prices will go down and then I'll get a good deal." But higher borrowing costs are never a good deal.
Let's see why. A house that sells today for $700,000 will cost you about $3759 per month with 10 percent down and a thirty-year fixed-rate mortgage at 6 percent. If rates blip up just one point to 7 percent, as some predict they will in 2006, your monthly mortgage payment is $4168—11 percent higher. If and when rates go up to 8 percent, still low by historical standards, that $700,000 house will cost you $4593 per month, a whopping 22 percent more than your monthly payment at 6 percent.
Will it pay to wait for rates to go up? When rates hit 7 percent, that $700,000 house will have to fall 11 percent in price to $625,000 for your monthly payments to be what they are today at $700,000 and 6 percent. What if rates rise to 8 percent? That $700,000 house will have to fall 19 percent to $570,000 to get you the same payments you'd get today.
A decline of 11 percent in home prices is certainly plausible in the short run, but there's one problem with this scenario: it assumes a direct relationship between home prices and the interest rate of the thirty-year fixed-rate mortgage. That direct relationship doesn't exist, because the thirty-year fixed isn't the only loan option buyers have. Adjustable, interest-only and option-payment loans have cushioned the effect of higher interest rates on home prices. The "I'm waiting for prices to go down" strategy also assumes that local consumer confidence and employment, the other drivers of real estate, will stay constant through future markets.
What are the chances of home prices dropping 19 percent? The top end did drop by that much or more in late 2001, but it took some heavy baggage—severe recession, the tech bust and an unprecedented terrorist attack—to do it. But what about the home that most buyers buy, the $900k Sunnyvale rancher or the $1.1M Palo Alto "starter"? The median price of a single-family home dropped just 9.8 percent in San Mateo County and 14.1 percent in Santa Clara County between the previous peak, April 2000, and the bottom in October 2001. That's the difference between best-case and worst-case markets, between red hot and stone cold markets, between a market in which almost every house sold (often with multiple offers) and a market in which only half the houses sold (and those that did were deeply discounted).
Could it happen again? Sure, anything's possible, but remember, the risk-averse are waiting out their competition because they're risk-averse. And only risk-takers bought homes in the forbidding days following 9/11, with jobs disappearing, prices sinking and no end to bad news in sight. Does that sound to you like a great time to buy? It didn't to many, but buying paid off big-time for the hardy few who did.
So give this market some respect. Buying doesn't get any less risky than this.
[In 2009 do I want these last words back? No. There's always risk in buying, in all markets but especially in markets that appear to have no risk. That's why I'm as certain as I can be that in a few years we'll look back on the risky market of 2009 as we once looked back on 2001 and say, "that was a great time to buy".]