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Shocker: Real Estate Prices and Interest Rates are Inversely Related!

April 11, 2010 Leave a comment

One of the more annoying things about reading about residential real estate is this repeated claim by those who should know better that real estate is an inflation hedge.

But, if you stop and think about it for a moment, you will quickly realize that’s a foolish argument. Residential real estate is principally financed by debt; therefore, its price should move inversely to inflation, just as do other debt securities such as bonds.

In any event, it’s very refreshing to see the New York Times accurately reporting on the relationship between real estate prices and interest rates:

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

Along with the sell-off in bonds, the Federal Reserve has halted its emergency $1.25 trillion program to buy mortgage debt, placing even more upward pressure on rates.

“Mortgage rates are unlikely to go lower than they are now, and if they go higher, we’re likely to see a reversal of the gains in the housing market,” said Christopher J. Mayer, a professor of finance and economics at Columbia Business School. “It’s a really big risk.”

Each increase of 1 percentage point in rates adds as much as 19 percent to the total cost of a home, according to Mr. Mayer.

The Mortgage Bankers Association expects the rise to continue, with the 30-year mortgage rate going to 5.5 percent by late summer and as high as 6 percent by the end of the year.

I would say that I hope this augurs financial literacy on the part of buyers of residential real estate, but even I am not that optimistic.

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