0:05

Federal interest rates are set to stay elevated

0:07

that to the latest Fed meeting, and the

0:10

housing market has still not recovered from the

0:12

pandemic. I'm

0:18

your host Matt Mere on the

0:20

managing editor of the Bigger Pockets

0:22

blog and today we're going to

0:24

right into this first story. So

0:26

last time I talked I went

0:28

over economic predictions and why economists

0:30

are nearly always wrong, and today

0:32

is just one more example of

0:34

how badly they can be off.

0:37

So. This is about the Federal.

0:40

Interest. Rates and The Federal

0:42

Reserve. Once. Again, Federal German

0:44

Jerome Powell giving us indications that rate

0:46

cuts might not be actually happening. So

0:48

let's set the scene at the very

0:51

beginning of the pandemic. The. Federal

0:53

interest rate which. Is. The

0:55

rate that banks loan money to

0:57

other banks. Those. Interest

1:00

rates were slashed to nearly

1:02

zero percent. At. The very beginning

1:04

of the pandemic to uplift the economy. Why

1:06

would they do that? well? During.

1:08

The Pandemic. obviously. We had massive

1:10

covered lockdowns that basically shut down

1:13

a lot of businesses that work

1:15

is littered not essential. There.

1:17

Was a lot of turmoil. There was

1:19

a lot of uncertainty in the environment

1:22

and general banking, etc. The.

1:24

Federal interest rates went down so

1:26

that it would be much easier

1:28

for banks, lenders, and businesses in

1:31

general to get access to funds.

1:33

That. Keeps economy moving, it keeps

1:36

going and so long as it's

1:38

happening. The. Risk of a massive

1:40

recession was significantly lower, although we did

1:42

happen to hit a recession in that

1:44

period. Induced. By the

1:46

contraction and economy. But. Either way,

1:48

having those interest rates low. Kept.

1:51

Everything moving, The. Problem is

1:53

that they remained low. For.

1:55

A very long time and this is where

1:57

a lot of the criticism around the Federal

1:59

was. Starts So federal

2:01

Chairman Jerome Powell who.

2:04

Runs the central bank, He suggested

2:06

and twenty twenty one that inflation, which

2:08

was a reaction to the supply chain

2:11

socks that were occurring during the covert

2:13

the damage. It was a reaction to

2:15

the amount of money that was being

2:17

went out. Because.

2:20

Of federal interest rates being so low because

2:22

of government spending, there was a massive stimulus

2:24

package that was passed by the federal government

2:26

and sent out whether it was to you

2:29

directly in check for. The. Of

2:31

Ppp well as ever given

2:33

to businesses to keep payroll

2:35

and. Employees on the books.

2:38

He suggested that inflation

2:40

was transitory. Quote transitory.

2:43

Basically. Suggesting that. The.

2:45

Root cause of all inflation.

2:47

Was. Due to supply chain shocks.

2:50

As. Effectively what that meant. The

2:53

problem is that inflation hit

2:56

nine percent shortly after. And.

2:58

Any time in places nine

3:00

percent which inflation being the

3:03

cost of goods rising over

3:05

a year period. So. For

3:07

instance, if inflation is nine percent, that

3:09

means that and whatever month it that

3:11

might be which which may have twenty

3:14

twenty two places. On. Average were

3:16

nine percent higher than may have

3:18

twenty twenty one. That in

3:20

mind the said. Waited

3:23

a long time to raise

3:25

the federal interest rate which

3:27

cause inflation to jump. And.

3:29

Because of their false belief that it

3:31

was just supplied seen shocks. Inflation

3:34

continue to run rape and economy for

3:36

prolonged period of time. Finally,

3:39

The Fed decided to start raising interest

3:41

rates and once they started raising their

3:43

Federal interest rates, Inflation

3:46

did come down. I'll be at not

3:48

as much as they one of it too. And

3:50

that's let us all to the the

3:52

problem we face today which is. the

3:55

consumer price index which is how we

3:57

measure inflation is a measure of a

4:00

basket of goods that consumers and services

4:04

use. So that includes energy

4:06

prices, it includes housing, it includes food,

4:08

groceries, et cetera. It's

4:10

still 3.5%. And the federal target

4:12

has always been 2%. The

4:15

federal target is always 2%. So

4:17

at 3.5%, that is considerable. So

4:20

in March, CPI, Consumer Price

4:22

Index, was at 3.5%. What

4:25

does this mean, though? And

4:27

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back. So before the break, I

7:59

said I was going to explain why this

8:01

matters, especially to real estate investors, because it really

8:03

does. We all think that the

8:05

Federal Reserve is sort of this boxed

8:08

in entity that controls the economy at large, and

8:10

it doesn't really impact real estate, but that's

8:12

completely wrong. It impacts real estate almost

8:15

as much as anything else does. So

8:18

if we go back to what

8:21

economists were saying at the beginning of the

8:23

year, and even late last

8:25

year, rate cuts were widely

8:28

expected to come sometime around mid-year,

8:30

even some projections had it this

8:32

month in April. They

8:35

are not happening. And I said at

8:37

the end of last year, in fact, in an article

8:39

about GDP on the Bigger Pockets blog, which

8:42

you can go read at the Bigger Pockets blog, that

8:45

unless inflation falls, the

8:47

idea of the Federal Reserve cutting rates seems

8:49

completely improbable. Now why would we even want

8:51

rates to be cut? Well, it's pretty simple.

8:53

It has to do with mortgage rates. So

8:57

whenever the Federal Reserve increases the

8:59

interest rate, it

9:01

becomes more expensive to take

9:04

on debt. It's more expensive to

9:06

get money. If you're getting a mortgage, you

9:09

can assume that any

9:12

time the rates are higher, your mortgage is

9:14

going to be significantly more expensive, and vice

9:16

versa. So that's why we want them

9:18

to decrease as investors, because it's cheaper to get

9:20

debt so that we can buy more houses. And

9:23

I wrote that article. Everything I said turned out

9:25

to be true, because as of last week, Jerome

9:27

Powell, our federal chairman, announced that

9:30

rate cuts are not in the

9:32

cards for the near future, and that

9:34

because of continued job growth and

9:36

continued inflation being in that 3.5%

9:38

range, there's no

9:42

rationale to cut rates at the

9:44

moment. In fact, there might even

9:46

be a reason to increase rates, because

9:48

inflation still hasn't come down to the

9:50

2% mark. Job growth is

9:52

still improving at a significant rate.

9:54

And the reason why that matters,

9:56

and you think, OK, well, job growth is good.

9:58

The problem with it is that it's not going

10:01

to be a good thing. is that whenever you

10:03

raise rates, the idea is to make sure that

10:05

the economy contracts in some way, because we don't

10:07

want it to get too hot. We want rates

10:09

to go up to stop

10:12

job growth so

10:14

that businesses pull

10:16

back on their spending, which in turn

10:18

reduces inflation. But instead, it

10:21

hasn't made a difference. And job growth keeps

10:23

going on. And therefore, there's literally no reason

10:25

whatsoever to cut rates. So for investors, what

10:27

it means is that mortgage rates not only

10:29

are going to remain where they are, they're

10:31

potentially going to get worse. So

10:33

for example, mortgage rates are pegged to

10:35

the 10-year US Treasury bill. Now

10:38

10-year US Treasury bills, they're bonds, they're

10:40

10-year bonds, you can buy them. And

10:43

the yield right now is about 4.6%. The

10:47

spread between mortgage rates and

10:50

bond yields, and this

10:52

is somewhat of a complicated subject, but all

10:54

you really need to know is that the

10:56

spread is the percent difference between a mortgage

10:58

rate and a bond yield. So

11:00

if the bond yield is 4.6%, and the mortgage rate is 7.6%,

11:02

specifically the 30-year fixed rate

11:07

mortgage that you would get for pretty much any

11:09

property, that's a 3%. That's

11:12

a higher than average spread historically. But

11:15

that's what we're actually looking at right now. And

11:17

as US Treasury bill yields have gone up,

11:20

mortgage rates have also followed suit.

11:22

And because US Treasury

11:25

bills are in some

11:27

way a indicator of

11:29

investor confidence, rising yields

11:32

usually means less confidence. It

11:35

means that there's more demand for those Treasury

11:37

bills because they're generally considered the most secure

11:39

asset on the face of the earth. And

11:42

so if more investors are flocking to them, what

11:44

does that tell you about risk in the economic

11:47

environment? It also means

11:49

that mortgage rates are going to continue

11:51

increasing, if not stay in that 7.5%

11:53

to 8% range, which while

11:56

historically in the middle of

11:59

what mortgage rates are, rates have been throughout history, it

12:02

is significantly higher than what we've been

12:04

dealing with for the past decade. And

12:08

that's had huge repercussions to an

12:10

already stagnant housing market. So

12:12

that asks the question, does the pandemic

12:14

from four years ago still cause today's

12:16

high interest rates? Or

12:18

is that just some sort of conspiracy? That

12:21

brings us to our next story. So

12:24

ultimately, there is an argument in the

12:26

world right now that the pandemic is

12:28

still to this day, impacting

12:31

the housing market, not in the way where

12:33

COVID is running rampant or anything like that.

12:36

But the conditions that were created because

12:38

of the pandemic are still

12:40

problematic today. There's

12:42

really three main factors here that characterize

12:45

the post pandemic market. One

12:48

is inventory has been extremely constricted,

12:50

that's kept prices up. A

12:53

renter nation, as renting is

12:55

far cheaper than buying, so there's

12:57

just more renters than ever

12:59

before. And then low mortgage

13:01

rates were locked in during and before

13:03

the pandemic. And that has

13:05

contributed to some of the issues that

13:07

we're facing today, which are characteristic of

13:10

the Federal Reserve's policies. So let's start

13:12

with inventory. Inventory

13:14

or what we would call housing supplies,

13:16

so the number of homes for sale

13:18

listed on the market, they've been extremely

13:21

low since the pandemic started. The

13:23

first half of the inventory problem was

13:25

characterized by the rapid purchasing of properties

13:29

that basically it wasn't that inventory

13:31

as a whole was low. It

13:33

was made low because demand was so

13:36

hot during the early months of the

13:38

pandemic. If you remember back then, people

13:40

were putting in 40 offers

13:42

on one home, and that created these

13:45

massive bidding wars that

13:47

sent housing prices skyrocketing.

13:50

But on top of that, it just meant that homes would go on

13:52

the market one day, and the next day they'd be sold. And

13:55

So with that in mind, yeah, there

13:57

was homes, there was inventory, people were.

14:00

Selling. But.

14:02

It's not like today's market

14:05

where today inventory is low.

14:07

And yes, demand is lower due

14:09

to the higher mortgage rates that

14:12

weeks for himself. but prices are

14:14

still elevated because supply is not

14:16

matching demand despite the demand being

14:18

lower. And that's what kept home

14:20

prices. As. High as they are

14:22

now. And. That in in a

14:24

way. Makes. It feel like

14:26

we're still an epidemic, we're still

14:29

dealing with Home prices are astronomical.

14:31

Fans hop as as. We.

14:33

Kind of live in a A. Rents are nice and

14:35

now. That's a a free that

14:37

you could. a tribute to the United States

14:39

at this point, especially in certain markets. So

14:42

with home prices so high in the cost

14:44

of a mortgage skyrocketing in the wake of

14:46

the pandemic. Renting. I'll

14:48

be at more expensive than a was

14:50

pretty pandemic in many cities. it is

14:52

cheaper to rent them by. And

14:55

is as close as some of the

14:57

city's is so astronomically expensive to buy

15:00

that renting is about the only option.

15:02

Why? Does this matter? For real? Say of

15:04

us are pretty obvious it comes down to

15:06

cashflow, For example, a home that used to

15:09

cost twelve hundred dollars a month to own.

15:12

And thirteen hundred dollars to rent out would

15:14

have netted you one hundred dollars in cash

15:16

flow for months. Now. Because

15:19

of higher mortgage rates as on top of

15:21

that higher prices to buy the home in

15:23

the first place, That same home could cost

15:25

two thousand dollars. For. Because rent growth

15:27

did not match the level of price growth,

15:30

It's only sixteen hundred dollars to rent. Which.

15:33

Means you're actually losing four hundred dollars in cash flow

15:35

every month. So. Long as

15:37

those conditions hold, the idea of

15:39

investing for cash flows extremely difficult.

15:42

And yes, cashflow exists in

15:44

some markets. Think Pittsburgh,

15:47

Think Buffalo. Think of some of

15:49

these secondary markets like Charlotte. You

15:52

can cash flow their i'll be answer

15:54

to codes. You can just goes in

15:56

the market. Assume you'll find that anywhere

15:58

but. With. an effort, you

16:00

can find a fixer-upper or a low-end

16:03

deal that you can actually cash flow

16:05

on. It's just so much more

16:07

difficult than it ever used to be. And if

16:09

mortgage rates, like we were talking about, are going

16:11

to increase or even just hold, it will

16:14

continue to be extremely, extremely difficult to

16:17

cash flow. And then

16:19

finally, the third issue that came from

16:21

the pandemic is what's now called the

16:23

lock-in effect. We've talked about

16:25

this a lot. The lock-in effect is

16:27

basically this idea that there was a

16:29

period of low interest rate mortgages that were

16:31

issued to a lot of individuals, so

16:34

think 3%, 2%.

16:36

And as interest rates rose, especially

16:38

in a quick period, so like

16:40

two years, they went from 2%, 3%,

16:42

all the way up to 8%, anyone who had those original 2% to 3%

16:49

mortgages are less likely to

16:52

actually sell their house in

16:54

return for an 8% mortgage that they'd have to

16:56

go buy somewhere else. So that's what we call

16:59

the lock-in effect. The lock-in

17:01

effect is a direct product of

17:03

the pandemic, and

17:05

it is because of the interest rate

17:07

response to the inflation issue that was

17:09

caused because of the

17:11

pandemic. So yes, we

17:14

let off this story by asking, is the

17:16

high interest rate environment that we live in

17:18

now a product of the pandemic? And

17:20

the answer to that is 100% absolutely yes. There is

17:22

no other way to look at it. Interest

17:24

rates would not be 8% right now

17:27

for a mortgage had

17:29

there been no pandemic. They

17:31

just would not. The federal reserve would not

17:33

have raised the federal funds rate all the way up

17:35

to 5.5% had there been no pandemic.

17:40

We probably still would have been around the 2% area.

17:44

There's a whole argument too about that

17:47

10-year lead up to the

17:49

pandemic of having low interest rates and low

17:51

mortgage rates were actually problematic in the long

17:53

run. But we cannot

17:55

discount the fact that the pandemic did not

17:57

upend the entire world of real estate. So

18:01

where does it end? Does it

18:03

even end? You think as a real

18:05

estate investor, like this has got to be one of the

18:07

worst periods to invest, probably since the

18:09

80s. Here's

18:12

the thing, real estate is local. Some

18:15

markets have actually, quote unquote,

18:18

recovered from the pandemic.

18:21

Once again, I'll point Pittsburgh, Buffalo,

18:24

and those other secondary markets that I mentioned. These

18:27

markets, if you are interested in actually

18:30

investing in these places, they're characterized by

18:32

a few things. One is steady growth.

18:34

They didn't explode like Austin or Boise

18:37

did. They maintain steady growth through the

18:39

pandemic from even before the pandemic. There

18:41

was no massive explosion of growth. When

18:45

I say growth, I mean home prices, rental

18:47

prices, even population growth. They

18:50

also have cash flow potential, which is

18:53

measured by rent to price ratios. So basically,

18:55

you're looking at how much it costs to

18:57

rent on average per month versus

19:00

the price of the home. And you divide those

19:02

two. And then you're also having

19:04

to look at migration stability. Now, there's a lot

19:06

of great websites that can give

19:08

you information on migration. Redfin is

19:10

one of those. You can look at where

19:13

people are actually looking to buy a home

19:15

on Redfin and it will show you which

19:17

cities are coming from, where they're going, etc.

19:20

Once again, because of

19:23

the pandemic markets of

19:25

Austin and Boise, and especially

19:27

the New York and San

19:29

Francisco declines in population, there

19:32

has been a lot of movement to some

19:34

of those cities like Pittsburgh, Buffalo, and the

19:36

other secondary markets that I keep mentioning. So

19:39

the window on actually investing there is

19:41

closing because people are more

19:43

interested in living there because it's cheaper. But

19:46

that also does mean that the reverse is

19:48

true, that those other markets that

19:50

used to be the hot spots, you

19:53

might actually be able to find better deals there because

19:55

people are leaving en masse. And

19:58

so you want to look at migration stability. emphasize

20:00

enough on how important migration is. So

20:03

anywhere where migration stability, steady

20:05

growth, and cash flow potential, those are

20:07

the places you want to look at

20:09

right now. That wraps up our last

20:11

story for today. We covered federal reserve

20:13

struggles with inflation and the potential for

20:16

steady, if not higher, rates as the

20:18

continued impacts of the pandemic affect

20:21

them and then the other impacts

20:23

that the pandemic had. You can

20:25

read all about these topics and

20:27

trends on the BiggerPockets blog. You

20:30

can go to biggerpockets.com/blog to read

20:32

more. biggerpockets.com/blog. Once again, my name

20:34

is Matt. I come on this podcast

20:36

every two weeks to give you the best stories in

20:38

real estate and I will see you next time.