The Expert Podcast

There is an invisible force in the real estate market that will keep prices from going down and keep houses from becoming available in the market that nobody's talking about. Even if somehow there were magically hundreds of thousands of new houses available in the market, even if somehow there was a new crop of inventory available, there's a factor that is semi-invisible but really easy to see if you do some math that will keep the housing market locked up tight for many years to come. Let's take a look.

So in order for the real estate market to go anywhere, there have to be homes available. Imagine the real estate market like a big game of musical chairs. There are millions of people in a house that are secure in a place of residence. They have a roof over their head, they have a home. In order for somebody to be able to buy a house and move in, somebody else has to move out. That's obvious. No argument there. There are some new houses coming into the market, but those are very quickly snapped up because there are currently more people waiting on the sidelines in that game of musical chairs than there are new houses coming on board. So that's not going to really change anything. For every new home transaction, somebody has to move out from a house. That's not going to happen. Here's why.

Take a look at this house. This is an average house in a northern suburb of Atlanta in Marietta. 459. This is kind of like an average house. You know, technically the median price for a home is a little less—it's in the upper threes, 360, 370—but most houses that are reasonably appealing for buyers are in this range. More importantly, in order for there to be houses available, there has to be move-up. Somebody has to move out. Somebody moves in, somebody moves out—that kind of thing. A house like this now is going to be almost impossible to become available, even more so than one year ago. You think the housing market was difficult in 2021 or 2020? Now that we're into 2022, there's a new factor that didn't exist before that's going to make the process even more crucial.

And that is interest rates. No, it's not what you think. It's not that new buyers can't afford the payments on it with the new interest rate. It's not that the new interest rate is going to make houses unaffordable. That's not it at all. Because people are going to figure out how to make their budget work. Even at five percent interest, a house like this is going to be $2,500 a month. Most homeowners are going to be able to afford that. Even if the rate goes up to 8 percent, this house might be $3,000 a month. You know what? For a homebuyer, they're going to figure out a way to pay $3,000 because in reality, rents are going up that much.

But here's the problem. If this person who owns this house—it's currently for sale, but you know that's besides the point, this is an example—wants to move up to another house, they are going to immediately lose $120,000 of buying power on their new house. Here's why. Most people who have mortgages, who bought a house, who were living in a house like this, bought the house more than six or eight months ago. Six or eight months ago, interest rates were two, three percent. Two years ago, they were two percent. So the vast majority of people who are in a house like this are paying roughly two percent interest.

So let's take a look at what that means. If you financed, let's say, $440,000—that would be, you know, like a ten percent, not even five percent down payment on this house. 460 minus 20,000, that's five percent. And you finance $440,000, your mortgage payment would be roughly $2,000 a month. Now, for the sake of this comparison, we're going to leave out taxes, insurance, HOA, all the other things—just a basic mortgage payment. On a 30-year fixed mortgage payment on a 440 mortgage is going to be $2,000, and you can do the math. You can do a mortgage calculator to see that.

If that person moved from the house right now and bought another house for the same price and financed $440,000 at five percent, their mortgage payment is now $2,756—$756 more for the same house. In the current market, if they move right next door and just bought the same house for the same price, they would immediately pay $756 more. What would they have to do to keep the same mortgage payment? They would have to go down in price $120,000. They would have to go down to like $320,000 at five percent to have their same mortgage payment as they have now. Who's gonna do that? No one's gonna go down in house just to have the same payment.

And if they want to go significantly up in house, which most people do, they're gonna pay first the difference in interest rate plus the difference in price. So if they want to go up, let's say, $150,000 in price and go from, let's say, 450 to 600—which is pretty reasonable upgrading house—they're going to be paying instead of 2,000, they're probably going to be paid more like 4,000 or 3,800. Their mortgage payment is going to double because of the extra interest rate.

So what's happening is this lower interest rate history is locking people in. Because it's almost like a forced refinance at a higher rate. And many, many fewer people are going to look to be trying to sell their house—even at a higher price. This person who bought this house—they might have purchased it for 250 ten years ago or seven years ago—but the extra $200,000 is not going to help them because they have to pay a higher interest rate.

And I get it. You can look at a lot of the math, um, and, you know, and figure—well, this person probably doesn't have a mortgage for 440 because they bought it cheaper. That's true, right? But the point is that if you have a mortgage currently at two percent, going up to a five percent interest rate on the same mortgage amount is going to increase your payment. So even if you go sideways on your house value—you're not upgrading your house—your mortgage rate, your mortgage payment's gonna jump up. No one's going to do that. Most people are going to look at it and say, "I have a deal on this house. I'm at two percent. Why should I change houses?"

Because if you change houses, you have to change mortgages. You can't carry your two percent mortgage to the other house. The price is only part of the equation. Many people are willing to go up in house—you know, they have equity in their house, they're willing to upgrade—even if they get over the fact that, you know, the extra equity in their house means they have to pay more for the next house. Some people can get past that because they're upgrading their house. But many people are not going to look at paying basically a mortgage penalty for switching loans.

Look, if you had a two percent mortgage, you wouldn't refinance to five percent. It makes no sense. But in effect, when you buy a new house, you're forced to refinance your mortgage at a higher price. If you think the housing inventory was bad in 2021, wait till you see 2022 and 23—when mortgage rates go from four and a half to five, where they are now, to five and a half to six. You get mortgage rates at eight percent, and nobody's gonna sell their old house if they're in at two or three percent. Nobody's gonna do that.

If you have to buy a house and you're renting right now, you may not have any choice. Paying six or seven percent, that's fine. But you're not losing on your interest rate. This is an invisible factor that's locking up people into their current house. It's almost like imprisoning you in your house because you have that mortgage. And most people like their house that they have now—fixing it up, making improvements. Most people upgrade their house because of maybe a desire to have something a little nicer, a need to maybe have more space.

But when you look at a house like this, where your monthly payment is going to go up $700 just to have the same level of house, most people are going to say, "Well, instead of doing that—that's $10,000 a year—I might as well take that $10,000 and put it into my house in terms of upgrades, improvements, additions."

That's fact. I don't think this has been talked about in analysis of the real estate market. There's many factors—new home construction, people moving up, renters coming into the market, different areas of the country having migration. That's all fact. That's all valid. But the mortgage rate shock is more than just the buyer saying, "Oh, my rate is too high." Most of the people that they're talking to about this are renters becoming buyers. The people who are going to hold on to their existing inventory are ones that are in a two percent mortgage, and they're not going anywhere.

Because it's a big difference. If it was two to two and a half percent or they're in a 2.5 and it goes to 3.1—that's not going to make a huge difference in your payment. Going from two to five or six percent—that blows it out of the water. On a mortgage that's $300k or $350k or $400k and above, you're talking many hundreds of dollars. If you have somebody that's already in a $500k or $600k mortgage, the interest rate alone could be $1,000 a month addition without going up in value.

So we'll see how it plays out. But expect that available inventory coming into the market is going to be dramatically reduced at the worst—or restricted at the best—because of the new rate. Even in 2020 and 21, there were some people that sold their house because they moved to a different location, different part of the country. There were some people that upgraded their house and moved, you know, in the same area but a bigger house or more land or whatever they wanted to get.

That's over. That's over. No one's going to want to swap out a nice, clean, safe, cheap two percent mortgage to jump into something at five. Because in addition to paying more for the house, now you're locked into paying more interest. In reality, the rise in interest might be more than how much you're going to pay for the house difference.

Look, if you go up $120k in house—from $440k to $560k—that's going to raise your payment the same as what the interest rate is. So, you know, your additional value or benefit from a bigger, better, newer house is going to be less of a shock to your finances, as will be the jump in interest rates.

So what is the market to do? Well, we can hope for more new home construction. That will help. We can look at possibly people who are currently in a house with a low mortgage, in some cases, using their equity to buy an additional house at a higher rate—keep their old house and rent it out as a long-term rental or even maybe a vacation rental. But that doesn't do anything to increase availability of housing units. All that's doing is having one person own two houses, then they own one primary residence. It doesn't add any rental inventory.

Again, housing market is a musical chairs...