Changing US Monetary Policy Could Hit Entry-Level Luxury Market Hardest

The US Federal Reserve, or Fed, announced some significant changes in monetary policy in March. Investors and prospective home buyers across the country are focused on what rising interest rates could mean for mortgage prices and how it could affect the housing market as a whole.

But there’s another element in the Fed’s changing policy that could affect buyers who rely on financing: the liquidation of purchases of mortgage-backed securities, or MBS.

For potential home buyers or real estate investors who trust mortgage financing, that means it’s time to be more choosy about the transactions you make, if any.

If you are looking for a primary residence for your family and eventually need to purchase something, regardless of external factors, then it would be wise to do so sooner rather than later. However, investors may do well to wait a while and look for properties in areas where demand is strong and which could offer annuity returns, because rising rates and reduced MBS purchase could hurt returns. of your investment.

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increasing rates

On March 16, the Fed approved the first interest rate hike in more than three years and indicated that there will be six more before the end of the year. After leaving the benchmark interest rate close to zero during the Covid pandemic, Fed officials raised it 25 basis points to a range of 0.25%-0.5%.

The movements will have direct impacts on the real estate market, and more specifically on the mortgage market. That’s because banks typically base their interest rates for loans, such as mortgages, on the Federal Reserve’s base rate. As it rises, so will the interest rates owed on mortgages.

Specifically, according to Zoltan Szelyes, CEO of Switzerland-based Macro Real Estate AG, fixed rates on 30-year and 15-year mortgages will rise as longer-term yields rise.

Jeff Samuels, Northern California regional manager for The Agency, said the impact on buyers and investors at the higher end of the luxury market will be minimal, because “a large percentage of these buyers are cash buyers or buy with large payments.” initials”.

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But the entry-level end of the luxury market is another story.

“Private banking opportunities and relationship-based mortgages are skewed toward high-net-worth individuals and therefore not affected as much by policy,” said Michelle Schwartz, managing partner at The Agency. “So, yes, the entry-level borrower generally relies on more conventional lending methods that are governed and supervised by securities.”

In other words, people looking to buy homes around $1 million are likely to be reliant on financing and thus could be affected by changing monetary policy. The markets of the South and the Sun Belt, such as Florida, Texas and Arizona— whose interest has skyrocketed since the pandemic — could see more buyers affected by the changes.

“It’s going to be a big challenge for a lot of households, I don’t know how they’re going to pull through,” Mr. Szelyes said. “Markets are pricing in 225 basis points of interest rate hikes this year, that’s quite a lot. Of that, only 25 basis points have occurred so far.”

He believes it could have a tangible impact on the US real estate market in terms of demand and therefore prices. Not everyone agrees.

“Mortgage rates have certainly gone up, but I don’t think it’s enough to be strict enough to crash the housing market,” said Amanda Agati, chief investment officer at PNC Financial Services Asset Management Group. “I think there will be some cooling [but] we have been in record financial condition territory for most of the pandemic.”

Settlement of MBS purchases

The increase in base interest rates is only part of the picture of monetary policy. The Fed also plans to reverse its quantitative easing policy and instead embark on a “quantitative tightening,” meaning it will start reducing government bonds and other assets it has bought in the market from its balance sheet.

Specifically, it will reduce the purchase of mortgage-backed securities.

That could mean that banks will have less incentive to offer concessional mortgages, since they will have to keep the risk on their balance sheets, rather than package that risk and sell it as a security to the Federal Reserve.

“If there’s less demand from the Fed, then the price of those mortgages basically goes up,” Szelyes said. “The banks are not willing to lend to so many people.”

If the criteria for mortgage applicants are tightened, mortgages will be more difficult to obtain.

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“The Fed hasn’t given any real guidance yet on how much they’re going to reduce balance sheets,” Szelyes said. “But if they also go ahead with what people call quantitative tightening, that will basically mean that spreads (mortgage rate versus Treasury yield) will widen, which means that mortgage rates, the 30-year mortgage rate will easily cross the 5% mark this year.”

“Certainly for the luxury market, it’s less of an issue as they’re generally wealthier… but still, if you’re looking to buy a new home and you’re calculating mortgage costs, which are 40% more higher than last year, then that will also affect housing demand,” Mr. Szelyes said.

Mr. Samuels did not agree that reducing MBS purchases would necessarily have an impact on the market.

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“While this is a possible outcome, it would be remiss to think that simply because there is a downside to MBS that tightening lending criteria is a given,” he said. “If we look at the pre-pandemic level that the Fed was buying MBS at, we could also reasonably expect lending criteria to be on par with that time.”

Ms. Agati also said that the decline in MBS purchases does not necessarily correlate with stricter credit standards.

He also pointed out that the Federal Reserve is not the only buyer of mortgage-backed securities. While it has been very active in the space, other investors could capture some of that demand, including investors based in underperforming environments like Europe or Asia.

“I think there will still be demand,” he said.

Where will the market go next?

Mr. Szelyes said that while, “so far, we are still in a market that is going strong in terms of price growth,” the market could quickly cool off if financing becomes an issue for buyers, not to mention the higher properties. prices due to inflation.

He thinks that higher mortgage costs combined with high house prices could negatively affect demand for real estate and, consequently, prices. Others, however, are more optimistic.

Ms Agati argued that the housing market is supported by consumer balance sheets, which are “really healthy based on all the liquidity that has come into the system in recent years.”

There is about $2 trillion in cash savings on US consumer balance sheets, he added.

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“From a consumer health perspective, even with some of the headwinds starting to emerge… we still think they are very well positioned,” said Ms Agati. “We think that will translate into continued demand for housing with security.”

He pointed to the “huge disconnect” between high demand and low supply, as well as supply chain disruptions, made worse by the war in Ukraine, adding to the “inflationary fire.”

“Prices have already gone up a lot, based on the tremendous demand, but they are going up even more because it’s so hard for builders to get the material they need,” he said.

In addition to strong demand, Ms. Agati pointed to other secular growth tailwinds, including the demographic shift in favor of single-family homes since the pandemic.

The wild card, he said, would be a recession.

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“While our base case is not that we fall into a recession in 2022, we have to be really honest about the challenges that are swirling in the background,” he said. “We are definitely in a slower growth economic environment and that could change the dynamic.”

She hopes that, all else being equal, that could happen in late 2023 or early 2024.

What should buyers do?

For Mr. Szelyes, who anticipates a reduction in home prices as well as potential rate cuts from 2023, now is not the time to trade.

“Currently I wouldn’t buy, because the prices are too high,” he said. “I would wait, if you don’t need to buy.”

The Agency’s Ms. Schwartz offered the opposite advice to entry-level luxury buyers, who are more cost-sensitive than other luxury buyers.

“I would advise a first-time homebuyer to buy something as soon as possible,” he said. “Even if you’re paying a little more, get a property that gives you stability, equity, and a solid asset for your future.”

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For Mr. Samuels, it all comes down to people’s situations and their goals.

“[Prospective buyers] You shouldn’t try to have a crystal ball,” he said. “Instead, they should look at their portfolio, take into account the current rate of inflation, analyze where they want to put their assets, and then, in discussion with their financial advisor, determine how their various options fit into their short and/or long term. . long-term goals.”

Ms Agati also advised entry-level luxury buyers not to wait, at least not those looking to buy a primary home who are going to make a purchase at some point anyway.

“It is quite clear that we are in the first step of a cycle of systematic rate increases,” he said. “If you have to get a mortgage to make the purchase, I think sooner rather than later certainly makes sense.”

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But his advice to investors, rather than those looking to buy a primary home, is different.

“If you’re a real estate investor, I think it’s more about choosing your location very carefully and choosing what type of real estate you’re investing in,” he said.

He noted that higher interest rates could limit the return on investment, but if investors choose a popular location like the South or the Sun Belt, “there is such tremendous demand that investment real estate assets are in very short supply.”

“So I think that dynamic is very beneficial for investors to the extent that you can get your hands on an asset,” he said.

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