Interest rate increase influence on house prices/ rental rates?

Question

I havent been around long enough to see high interest rates. How much does it usually affect house prices? Common sense says that when rates go up prices go down but what could we expect to see happen if rates went up to 15% in next 5-10 years? What would we expect to see happen to rental rates?

Any comments from people who were in the game when rates were up in the past would be much appreciated.

Brian P. · Answer

The fact is if you only take the hike in the interest rate as the only factor, prices will go down. But that would require that every thing else to remain the same, and that doesn't happen, it is always accompanied by other factors, so the final result will fluctuate.

However as we saw in 1989 in the area of California that I was doing business in that other factors come into play. At that time only 5% of the buyers could buy the average price house and when the lenders started to raise loan rates the dam broke because that low 5% number went even lower thus an instant buyers market for qualified buyers, and falling prices for sellers. But the real buyers kept waiting for prices to stabilize so prices keep dropping even more.

I went through 81-82 and the credit crunch of 1966 and other periods, When interest rates start to rise I get an uneasy feeling.

Jeff S. · Answer

Unfortunately, common sense is not always correct though Iâ€™ll note that this is an extremely common belief.  In fact, the data doesnâ€™t support most of the statements above.

Please see the chart below showing both 30 year interest rates and home prices since 1971.  I cite my sources below.

(Right click on image and select "view image" to resize)

Here, I normalized the data so the curves overlay and I shaded the dominant periods of interest rate increases.  The resulting direction of home prices during these periods is shown below:

Periodâ€¦â€¦â€¦. Home Price Direction
1972-1982 ---- Flat   (you remember 18% rates donâ€™t you?)
1983-1984 ---- Flat
1993-1994 ---- Increase
1998-2000 ---- Flat
2003-2005 ---- Increase

Note too of course, the huge drop in rates since the mid to late 1990â€™s through now.   Home prices took their legendary spike in 2005 and have dropped since.

I conclude from this graph that there doesnâ€™t appear to be any reliable correlation between interest rates and home prices.  Of course, Iâ€™d welcome a different interpretation.

My personal sense is that the next spike in interest rates will cause home prices to increase.  Many people are buying time watching prices fall with no motivating impetus to buy.  A sudden spike might motivate them to jump in while they still believe they qualify for a loan (i.e. panic).  The resulting increase in demand could cause home prices to increase. Of course this could also motivate banks to start releasing their shadow inventory at a greater rate, meeting demand and causing prices to stabilize.

In sum, itâ€™s anyoneâ€™s guess, but itâ€™s clear (to me at least) that basic supply and demand economics are too simplistic to predict the relationship between interest rates and home prices.

The sources for this chart are:
30 Year Interest Rates from Freddie Mac (averaged by quarter): http://www.freddiemac.com/pmms/pmms30.htm
Home prices from John Shillerâ€™s â€œIrrational Exuberanceâ€ website: http://www.irrationalexuberance.com/

Bill Gulley · Answer

While prices fall when rates go up, that is only to the extent prices fall to a level that is supported by demand, rents and appreciation. There is a demand for housing regardless of interest rate fluctuations. At 15% prices will fall and the market will slow. IMO, our local market seems to be in equalibrium with rates at about 9 to 10%.  Real estate is local and while rates will bump the local market either way rates have little effect on the real demand for housing.

Also, as rates go up and make qualification more difficult, sellers will resort to financing at lower rates to move the property. When rates were 18+%, there was a great deal of assumptions, sub-2s and installment contracts (which promted the due on sale clause).

Kevin C. · Answer

I remember double digit rates, I was a buyer back then and I don't recall seeing home prices spike when rates fell.

When we bought our second home in the early 80's ('82 or '83 I believe), we had a 40 year variable rate loan.  I'm pretty sure that loan started in the low to mid teens.   A few years later when rates dropped considerably I don't recall home prices spiking.

Higher interest rates may have a short term effect on home prices, but in my personal experience with housing markets over the past 31 years, I saw little correlation between interest rates and home prices.

These are very different times we're in today, so the past may not be a very good indicator of the future.

Bryan Hancock · Answer

Bingo Brian!  "Ceteris paribus" is a rather broad assumption.  When rates go up hundreds of other factors to housing prices adjust as well so it isn't really very easy to tell what is going to happen.

At the end of the day wages are sticky and people can only afford so much house, which should serve to dampen any huge movement in prices in either direction.  Releasing "shadow inventory," banks adjusting how they lend, new capital flows to development, etc. all play a big role too.

However...if you take all of the other factors of the equation out a rise in interest rates should mean a fall in prices because the people with the sticky wages can afford less house.

Will Barnard · Answer

I tend to agree more with what Jeff stated as well as the fact that interest rates vs home prices ignore all other factors which contribute to home price values as Brian eluded to.

Secondly, I don't see interest rates hitting double digits anytime soon or even in the next decade. If you look at the national debt, our country is in trouble. The government has self-interests to keep interest rates lower, otherwise, interest on the national debt doubling could send the country into a hole without a ladder.

Paul OConnell · Answer

If you make sure there is no prepayment penalty, then you could lock in a lower rate in say three years if rates start to creep too high.

Even if there is a prepayment penalty it may make sense if you think rates are going to get that high to pay the penalty.

Casey S. · Answer

So I guess we have to wait and see.

I'm not as much nervous about my propertys themselves as I am the loans on some of them. Local bank, 5 year with 1 year ballons on 15 years. The bank says they have never called a note at the end of 5 years but they have the right to. If rates shoot up they will follow suit and if rent doesnt come up I could end up going from making money each month to losing money each month.

Bryan Hancock · Answer

Prices will go down in the short run if rates go up.

If the general prices go up for materials the replacement costs will go up too.  Without material cost increases or inflation rates north should drive housing prices south.  However, you are likely to have both rates and prices going up in the near term so it is a bit unclear what will happen to housing prices.

Interest rate increase influence on house prices/ rental rates?

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