Are we about to see a DROP in Real Estate Prices?

What's up you guys? It's Graham here. So, it's no surprise the economy is doing better; stocks are higher than ever, and real estate has been going up steadily since 2011. It's also no surprise that much of that recent momentum was largely fueled by extremely cheap lending.

See, the thing is, when the economy goes and takes a ship, we lower interest rates to incentivize people to borrow and spend, which then stimulates the economy. So think of almost low interest rates as just like catnip for the economy. But obviously, this can't last forever because if interest rates stay too low for too long, inflation can get out of control. So, you have to raise interest rates in a bettering economy, like what's happening right now. But what does this mean for real estate prices? All of a sudden, borrowing gets more expensive, and when borrowing gets more expensive, so does the cost to own real estate.

So what's gonna happen? Will real estate get less expensive as interest rates go up, or is it better to lock in a low rate now before it gets even higher? For real quick, a little bit about me for anyone who's watching my channel for the first time: make sure to LIKE and subscribe. I started selling real estate in May of 2002 as a real estate agent here in Los Angeles. This is pretty much a time where real estate just hit its peak and was on its slow subsequent decline. Over the next four years, I was able to witness real estate at a time when nobody wanted to buy; when inventory was through the roof; when a normal homeowner could not sell their house because of competing with short sales and foreclosures that were selling for 50% of their value.

The only people buying at that time for the most part were cash investors. From there, I ended up investing in three properties myself while still working as a real estate agent, and then buying another property in 2016, another one in 2017, and yet I'm looking again in 2018. And throughout all of this, I've still worked full-time as a real estate agent. So, I've been able to see real estate at near its peak and at its very bottom, and now we're pretty much on the top again.

Now, present day in 2018, people are more confident about real estate, and interest rates are still at historic lows. As an investor, it's becoming extremely difficult to find deals that make sense; I'm competing with thousands of other people out there that want the exact same thing that I do. But the biggest variable I see out there isn’t so much the lack of inventory; it's the interest rate, and it's steadily going up, therefore making real estate steadily more expensive to own.

In 2016, I was fortunate enough to get a 30-year fixed-rate loan at 3.375% interest. In 2017, I was able to get an investment loan, 30-year fixed for 4.5%. In 2018, if I wanted that exact same loan, it's going to cost me more like 4.7%. That is a thirty-five percent increase over two years. So why should we care? See, the thing is interest rates directly affect how expensive it is to own real estate.

Let's take a $500,000 home for an example. With 20% down, a $400,000 mortgage at a 4% interest rate over 30 years is going to cost you $1,900 per month. Now at 6%, that exact same loan is going to cost you $2,400. For the exact same loan, that is a $500 per month difference. For instance, if you're qualified to buy a $500,000 home at a 4% interest rate where your payment is going to be $1,900 per month, if interest rates go up, the cost to own that property goes up as well, and your loan becomes more expensive. To the point where if you wanted that same $1,900 per month payment, you would only then qualify for a $400,000 home at a 6% interest rate.

This means that you qualified for 20% less home as interest rates go up 2%. And that same concept applies to investors as well. That $500,000 home that was previously generating you $500 per month in cash flow and a 4% interest rate now gives you zero cash flow at a 6% interest rate. So in that example, something needs to happen; either rents need to go up or property values need to go down in order for that to cash flow.

Basically, the higher the interest rate, the more money the property needs to make in order to compensate for the higher cost. But what does this mean for real estate prices? Are we destined to see a slow decline in price as interest rates go up and the cost of owning that property gets more expensive? Well, the actual results may somewhat surprise you because it did to me. See, historically, us freaking out over higher interest rates is rather comical given that in the 1980s, the thirty-year mortgage rate was nearing eighteen percent. By the 90s, the interest rate was more like ten percent, and then since then, it steadily decreased.

So what about real estate prices back then in the 80s when the interest rate was eighteen percent? How are prices doing? Well, the surprising answer is it really didn't have that much of an effect. Development did slow down as borrowing money just became too costly to make sense, but the dwindling supply kept prices rather intact. Historically speaking, interest rates have very little direct correlation with the value of real estate. The reality is that there are so many other market factors to consider that have a much greater impact than the interest rate alone.

Now, one interesting note here is that interest rates are usually increased in two scenarios. Number one is when the economy gets better, and number two is to combat inflation. See, the thing is, in an improving economy, people tend to do better as well; unemployment is lower, people are making more money, wage growth is increasing, and with that, people are spending more money. Now, this bodes well for real estate because people then have more discretionary income to spend on their home.

Now, in a second scenario, if interest rates are increased to combat inflation, this also bodes well for real estate, which is typically a hard asset that keeps pace with inflation. As build costs get more expensive to recreate that same property, this means that oftentimes the increase in property value just from inflation can outweigh any potential decrease caused by rising rates, and the net benefit is actually positive for real estate.

This is often one of the big advantages of real estate, its ability to weather the storm of inflation. And as they say, when it comes to real estate, it's location, location, location. A bigger determination of price is still the age-old supply and demand. Local market health is a much stronger indication of real estate prices versus interest rates alone. If development isn't enough to keep up with the current demand, supply goes down and prices go up. As supply increases and demand eases, prices then go down.

That's all some pretty common-sense stuff. So with that said, historically speaking, interest rates have very little direct correlation with the price of real estate. While rising interest rates absolutely affect affordability, and we can't deny that, local market conditions of supply and demand have a much greater impact than just about anything else.

So with that said, what do I think about it, and what's my opinion on the current rising interest rates? Well, right now what I'm noticing is that rising rates give people an urgency to buy right now before interest rates rise higher in the future. This is the type of urgency I have yet to see before in my entire career. And you know what? I'm in the exact same boat as this. I want to get another mortgage over the next six months so I can lock in an interest rate now, then wait another year for that same property just to get more expensive to own.

Rising rates to me mean that previously cash-flowing properties that made sense at a 4% interest rate are now actually losing money when interest rates are closer to 5%. That same property just costs more expensive to own, even though in theory, property values should go down to compensate for the extra cost of owning that property. But in reality, the lack of supply is still keeping property values going up and still selling at a record rate.

My pure unbiased prediction here, all things considered, is that I think we're still going to see upward pressure on real estate prices even as interest rates increase. Now, with that said, local market conditions will obviously have a much greater effect than interest rates alone. If you're in a city where they're starting to over-develop, then that could have a negative impact on real estate prices much more than just rising interest rates alone.

This is why I tend to believe we're seeing a slowdown of real estate in New York as people just tend to over-develop these areas and get a little ahead of the market. It's not so much that interest rates are going up; it's just that there's more on the market, and there's more inventory and more people competing against one another for a limited amount of buyers.

I really believe the reason we're not seeing that same result here in Los Angeles is because LA still has a huge shortage of inventory, and there's simply not enough development right now to meet the current demand. This could change in the future if LA opens up its zoning and allows for more dense development. Hey, very well, we could see a decline of real estate prices, but that's not directly correlated with the cost of the interest rate.

Now, I don't think the Fed is so stupid as to increase interest rates an absurd amount as to shock the market. But I think it's gonna be in very small, slow incremental rate increases that are gonna be pretty easy to swallow, that we're barely going to notice month to month, and it's gonna give everybody time just to adjust accordingly. But I do have to say that for myself, affordability is definitely a concern. I cannot find a cash-flowing property in Los Angeles at a 4.7% interest rate; it just doesn't happen unless I find the unicorn of a deal.

But just as devil's advocate here, that if prices do go down, in theory, affordability should remain the exact same. See, the thing is, if property values go down but interest rates go up, the property still costs the exact same amount as if property values were higher and interest rates were lower. The net cost just usually happens to be the exact same, whether you're paying more for the value of the property or you're paying more for the interest of that loan.

So in that case, still assuming a slow and steady growth, it would still be cheaper to buy now than to wait a year or two when property values could potentially still be going up or the cost of the loan continues to go up as well, making it just all-around more expensive in the future. But like I said previously, local market conditions will have a much greater impact on real estate prices than just the interest rate alone.

For instance, development or the lack thereof will likely have a much greater correlation with real estate prices than how much the loan will cost you to own. Of course, these are all just my opinions and my theories and not financial advice, and please you guys do your own research and don't just listen to some guy on YouTube for your financial advice. Not financial advice, whatever I have to say not to get sued.

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