How high will mortgage rates climb in the next 36 months?

Based on the comments, I don’t think my argument is clear. Let’s imagine if you got 100% return annually on a 30 year bond. Would you keep a rental property, or sell it to buy the bond?

Sure, 100% isn’t realistic, but what about 50 or 25? What about 10? How high does the rate have to be for investors to sell the property to trade to the bond? That’s the argument I’m making. Inventory is not the problem. Rates not being high enough to be a viable alternative is the problem. There’s plenty of potential inventory that’s sucked up by investors who will trade up for the right yield on bonds. We just need to get rates to that level.
 
Based on the comments, I don’t think my argument is clear. Let’s imagine if you got 100% return annually on a 30 year bond. Would you keep a rental property, or sell it to buy the bond?

Sure, 100% isn’t realistic, but what about 50 or 25? What about 10? How high does the rate have to be for investors to sell the property to trade to the bond? That’s the argument I’m making. Inventory is not the problem. Rates not being high enough to be a viable alternative is the problem. There’s plenty of potential inventory that’s sucked up by investors who will trade up for the right yield on bonds. We just need to get rates to that level.
I get what you're saying, why would a property investor continue to hold property when they can achieve higher returns in a less risky investment in the near term? And that might be true for an investor sitting on cash making a decision of whether to buy property or a bond today. Though in reality a 30 year treasury bond currently offers 3.9% and is subject to federal income tax. It's a negative return after tax and current inflation.

It's a bit more complicated for a current property owner. In your example, an investor should compare the after tax 30 year ROE of the hypothetical property and 30 year bond. In theory the property should provide a higher return than a bond due to the additional risk and reduced liquidity associated with owning the property. The property can also be leveraged quite heavily, which can magnify the ROE when the cost of debt < cap rate. Retail investors generally don't have access to leverage against their bond holdings. Property also offers a depreciation tax shield. No such tax shield for bonds, though there are some bonds that are exempt from or defer certain taxes (though typically their yields adjust downward for these features). Property also offers the ability to raise rents. Treasury bond interest payments (or accruals) are a fixed % of face value.

You might have a better argument if you're talking about an FCB sitting on big unrealized gains from their property purchases a few years ago. Even if you can show that person they should sell and buy a US freedom(TM) bond for a higher safer yield, you're going to run into other challenges like cultural preferences for property.

The powers that be are in a pickle. They created an interest rate environment that allowed so many US property owners to purchase or refinance into lifetime low rates. They flooded people's & businesses' bank accounts with free money. They increased M2 money supply by over 40% in just 2 years. They said inflation was transitory. Now they say they can engineer a soft landing.

Edit: Also, rates don't exist in a vacuum for mortgages or bonds. Who holds a significant amount of debt instruments (aside from the fed)? Investors, particularly banks, insurance companies, and pension funds. What happens to the market value of existing debt instruments when new debt provides higher yields? The market value of existing debt declines. Some banks already have negative equity when they measure their investments at market value. It's not too much of a problem if they can hold the investments to maturity, but it does create other problems, especially if they need to raise cash or pay a higher yield to keep deposits from leaving. Insurance companies have reserve requirements, and the value of their reserves have already declined substantially. Pension funds have to raise cash to pay out benefits and also have funding requirements. All of these major financial players can run into serious problems if they're forced to liquidate holdings with large unrealized losses. Forced liquidations can lead to a cascade of falling prices, triggering other forced liquidations, leading to more falling prices... Hiking the long end of the yield curve too quickly can cause systemic failures.
 
Last edited:
Based on the comments, I don’t think my argument is clear. Let’s imagine if you got 100% return annually on a 30 year bond. Would you keep a rental property, or sell it to buy the bond?

Sure, 100% isn’t realistic, but what about 50 or 25? What about 10? How high does the rate have to be for investors to sell the property to trade to the bond? That’s the argument I’m making. Inventory is not the problem. Rates not being high enough to be a viable alternative is the problem. There’s plenty of potential inventory that’s sucked up by investors who will trade up for the right yield on bonds. We just need to get rates to that level.
First of all, you can't just sell a rental property due to lease contract.

Secondly, Martin can tell you that it's a much better option to keep the rental property than buying bonds. Also, Martin already addressed the tax consequence of selling an investment home. And now someguy brought up the tax consequence of bonds interest. It's taxed as income tax, not capital gain.
 
First of all, you can't just sell a rental property due to lease contract.

Secondly, Martin can tell you that it's a much better option to keep the rental property than buying bonds. Also, Martin already addressed the tax consequence of selling an investment home. And now someguy brought up the tax consequence of bonds interest. It's taxed as income tax, not capital gain.

It's not a black and white binary decision to sell a rental property, there are a lot of factors involved like how much equity is in the rental, what interest rate the mortgage is or if there is a mortgage, how much cash flow the property throws off, etc. Bond yields won't stay high forever and real estate, especially with reasonable leverage, has almost always outperformed bond returns. Just because rates go to 8% or higher doesn't mean that you'll all of sudden get rental property investors flocking to sell their rentals. One way to bring more inventory is to have mortgage rates come down, then you'll get all of the move-up buyers looking to upgrade their home.
 
If you really want to flood the market with inventory, you should have congress update the tax codes in the US. The tax code is telling every American to be a business owner or a RE investor. Whoever wrote the US tax code is definitely a RE developer.

It's unbelievable to believe that one can pay little to no taxes for a rental property but middle class (W2) workers get taxed the most on physical/actual labor.
 
Last edited:
It's not a black and white binary decision to sell a rental property, there are a lot of factors involved like how much equity is in the rental, what interest rate the mortgage is or if there is a mortgage, how much cash flow the property throws off, etc. Bond yields won't stay high forever and real estate, especially with reasonable leverage, has almost always outperformed bond returns. Just because rates go to 8% or higher doesn't mean that you'll all of sudden get rental property investors flocking to sell their rentals. One way to bring more inventory is to have mortgage rates come down, then you'll get all of the move-up buyers looking to upgrade their home.
Really feels like you're "fighting the Fed" with your positions. Bond yields can and will stay high for mich longer than you've experienced in your adult working life. Rents a re a function of prior real estate valuation. As valuation gets corrected through panic selling or large scale institutional sales rents then come down, putting mroe pressure on RE income investors. The Fed is trying to crush real estate speculation by prime borrowers. We're all going to be collateral damage.
 
Really feels like you're "fighting the Fed" with your positions. Bond yields can and will stay high for mich longer than you've experienced in your adult working life. Rents a re a function of prior real estate valuation. As valuation gets corrected through panic selling or large scale institutional sales rents then come down, putting mroe pressure on RE income investors. The Fed is trying to crush real estate speculation by prime borrowers. We're all going to be collateral damage.

I'm not fighting the Fed as I'm net short in the stock market. I know the Fed will go higher than the market thinks and will stay there longer than the market thinks. I don't see small real estate investors and institutional investors mass selling residential properties. There is a general structural shortage of housing so that itself will keep somewhat of a floor under market, especially in areas where it is difficult to build a large number of new housing units. One of the problems that we have with inventory now is that so many people locked in rates in the 2%s to 3%s so unless those owners have to sell they won't be selling anytime soon. The Fed controls short term rates and mortgage rates are based on long term rates so my argument that the higher the Fed goes and the longer that they stay the more they'll invert the yield curve and end up keeping mortgage rates contained.
 
Yah! the people who borrowed hundreds of thousands of dollars @ less than 3% are going to keep their house.
If they have to move they'll rent it out and rent a new one @ their new location.
 
Yes need a deep recession or some kind of black Swan event to trigger and force home owners to sell and start the panic selling.
But one would argue if such event happen Fed will revert the policy quickly or government bailout…
 
I'm not fighting the Fed as I'm net short in the stock market. I know the Fed will go higher than the market thinks and will stay there longer than the market thinks. I don't see small real estate investors and institutional investors mass selling residential properties. There is a general structural shortage of housing so that itself will keep somewhat of a floor under market, especially in areas where it is difficult to build a large number of new housing units. One of the problems that we have with inventory now is that so many people locked in rates in the 2%s to 3%s so unless those owners have to sell they won't be selling anytime soon. The Fed controls short term rates and mortgage rates are based on long term rates so my argument that the higher the Fed goes and the longer that they stay the more they'll invert the yield curve and end up keeping mortgage rates contained.
The Fed balance sheet, still ~$2T, is their mechanism for the long end of the curve. I hope you' re net short the right parts of the market as earnings aren't deteriorating everywhere. I think equities will surprise to the upside. And there is no shortage of housing as even up here in the hardest part of CA to build large scale developments we have 500,000 units coming online in the next few years.

I feel the key statistic we should be examining but which never gets discussed is the percentage of Irvine properties that are investor owned. Do you know that figure? That has been a good proxy nationally so far for pain.
 
This might be Irvine specific but I think FCBs prefer real estate over bonds. And if they are not financing... as soon as prices dip... they just buy more which makes inventory less. :)

And ironically... Irvine is one of the few cities in the OC that still has new home developments (multiple in fact), yet prices are still high.

Someone 'splain that (other than USC because he knows why). :)
 
The Fed balance sheet, still ~$2T, is their mechanism for the long end of the curve. I hope you' re net short the right parts of the market as earnings aren't deteriorating everywhere. I think equities will surprise to the upside. And there is no shortage of housing as even up here in the hardest part of CA to build large scale developments we have 500,000 units coming online in the next few years.

I feel the key statistic we should be examining but which never gets discussed is the percentage of Irvine properties that are investor owned. Do you know that figure? That has been a good proxy nationally so far for pain.
Some education for me - what were the interest rates and down payment req'd 1 year ago for an investor looking to buy an income property and how do those compare to today?

If cap rates are >> cost of money then no need to sell but if the equity can get a comparable or better risk free return a ton of mom and pop investors will unload their rentals ahead of the next eviction moratorium and preserve their capital.
 
This might be Irvine specific but I think FCBs prefer real estate over bonds. And if they are not financing... as soon as prices dip... they just buy more which makes inventory less. :)

And ironically... Irvine is one of the few cities in the OC that still has new home developments (multiple in fact), yet prices are still high.

Someone 'splain that (other than USC because he knows why). :)
Because we don't have the guts to tax non-resident owners higher. I've said it many times... raise property taxes, then give a deduction on the state tax filing. Out of staters and foreign investors pay up on higher taxes. Make it 1%, and watch their return plummet and make them sell for better things. We all know they won't do it, even though it would solve most of the problem on the spot.
 
Because we don't have the guts to tax non-resident owners higher. I've said it many times... raise property taxes, then give a deduction on the state tax filing. Out of staters and foreign investors pay up on higher taxes. Make it 1%, and watch their return plummet and make them sell for better things. We all know they won't do it, even though it would solve most of the problem on the spot.
I agree that out of state owners should be paying higher property taxes. I mean, out of state college students have to pay higher tuition fees, so should out of state owners.

I guess they're just afraid that the housing market might plummet if you take out the FCBs. On the other hand, with FCBs in play, it's causing the housing market to be out of whack.
 
Some education for me - what were the interest rates and down payment req'd 1 year ago for an investor looking to buy an income property and how do those compare to today?

If cap rates are >> cost of money then no need to sell but if the equity can get a comparable or better risk free return a ton of mom and pop investors will unload their rentals ahead of the next eviction moratorium and preserve their capital.

Down payment requirements for a rental property haven't changed, they are still a minimum of 25% down. At the lows of the market in 2021, you could have gotten a 3% mortgage for a rental property purchase while today you are looking at around 7.50%. Not all real estate investors are putting 25% down, some are putting 50% down, and some are even using all cash (many of these are using 1031 exchange funds). There isn't going be an major unloading of rental properties unless the laws making rentals a lot more expensive, especially not by FCBs.
 
What isn't being openly discussed are the radical changes in Loan Level Price Adjustments (LLPA's) - additional rate or fee adds by Fannie/Freddie based on risk - real or imagined. Assuming .25 in fee = .125 in rate, take a look at an LLPA matrix in 2016 and the coming LLPA matrix in May 2023.

2016 - https://gonms.org/wp-content/uploads/2016/09/llpa-matrix.pdf

2023 - https://singlefamily.fanniemae.com/media/9391/display

Please note that LLPA's change annually, but sometimes mid year as well. The 2016 is not a baseline per-se, but an idea of what was considered risk then versus risk now. Rental property, Condo price adds, LTV's over 80, high and low FICO's, even DTI's now have significant LLPA hikes. Essentially if you had a rate of 5% in 2016, today you'd need to price the rate between 6 and 7 percent simply due to additional "risk based fees".

Most lenders have started pricing the May 2023 LLPA's already into their March price matrixes. Expect to see Agency lending rates climb significantly over the next few weeks.
 
When mortgage rates go up...the people who got 3% loans feel richer.

I wasn't going to sell my house a year ago when prices were @ peak.
Now that prices have come down 10%, and mortgage rates are much higher, I'm even more determined to keep my house.

I think housing inventory is going to stay low in 2023.

What about new housing?
Housing starts are @ 1,300,000 today.
It's been dropping like a rock since APR 2022 peak.

Personally, I am experiencing this dip in my construction business. but god dam did I make a ton of money between 2021 and 2022.


united-states-housing-starts.png
 
Last edited:
When mortgage rates go up...the people who got 3% loans feel richer.

I wasn't going to sell my house a year ago when prices were @ peak.
Now that prices have come down 10%, and mortgage rates are much higher, I'm even more determined to keep my house.
This is why I fail to understand Mawsome Sauce's point on why investors would be selling during housing downturn. Why would you sell your rental after a 10% drop, especially if you locked in a low rate, when you could have done so at peak? Higher rates would make you just feel better about your mortgage.
 
I know a lot of rich people who collect houses.

They are smooth brained monkeys like me.
We don't know how to buy bonds or stocks.

We only have one strategy and that is to have 100 rental houses before we retire.
Everything else is financial mumbo jumbo.

We are all waiting to collect more houses. 10% is not enuf.
 
Last edited:
Back
Top