Here's a snapshot of a conversation I am having about three times a week, courtesy of the red hot Denver housing market:
Client: "Is this house really worth (pick your favorite number) $350,000?"
Me: "I don't know, but someone is going to pay it."
This is obviously a less comfortable position than in previous years, when the value of homes was easily measured by past comps instead of present demand.
But right now, present demand is determining value, and with demand overwhelming supply, prices are going to continue going up. Many buyers are even factoring in projected future appreciation when determining what to offer for a home.
When will it end? The question of when it will end is a good one, and an important one. Obviously, interest rates are a huge motivating factor right now, as rates in the low 4's remain highly attractive to buyers scrambling to lock in a 30-year mortgage payment before higher rates make homes less affordable.
So when and how will our market turn? Of course, there's no way to know for sure, but I believe any slowdown will start with new construction, which is far more likely to freeze up when rates rise due to the chilling effect of payment shock.
Right now, virtually all new single family construction in the metro area starts at $350,000 and goes up. Truth is, there are only a handful of new communities where buyers can purchase anything in the $300s.
Let me show you why I think higher end new construction will be the first domino to fall when rates finally surge. It's simple math, really.
- $400,000 purchase with 20% down payment = $320,000 loan; At 4.25%, the P& I payment on a 30 year loan is $1,575.
Assuming 10% appreciation (which is not unrealistic for 2015), let's project forward 12 months.
- $440,000 purchase price with 20% downpayment = $352,000 loan; At 5%, the P& I payment on a 30 year loan is $1,890.
That means 12 months from now, under this very realistic scenario, the payment for the same home is nearly 21% higher than it is today.
New construction is selling like crazy right now, and this is why.
But a year or two from now, if payments really are 21% (or more) higher for the same home, it's going to have a chilling effect. In fact, you could easily argue that builders are racing the clock to build and sell as many homes as possible based on low payments. When payments go up as interest rates rise, and they will at some point, demand for new construction will slow appreciably.
The most bulletproof sector of the market, in my opinion, remains the sub-$400k market. That's because supply is finite, builders won't build them (because they can't do so profitably), and it's what the vast majority of buyers are looking for.
When rates rise, I see continuing activity, but with buyers getting squeezed into smaller and smaller resale homes and condos as they literally are priced out of the new construction market.
Risk in real estate is directly proportional to market positioning. The entry-level and sub-$400k markets are darn near bulletproof in my opinion, based on an overwhelming demand-supply imbalance. But when you start tapping into new construction, where supply is not fixed, rates will matter more.
For builders, the race is on. Sell 'em now, while rates are low. Because when rates rise and the market slows, the first place to clear out will be the sales office of your favorite local new construction builder.