Inflation and Boston Condo prices …
Homebuilder sentiment dropped in January as inflation concerns and supply-side challenges broke four months of rising construction-sector confidence, the National Association of Home Builders reported, citing the latest NAHB/Wells Fargo Housing Market Index (HMI).
January’s reading of 83 was down one point from December and does not account for a recent jump in mortgage interest rates, the NAHB said in a press release. The reading has remained at 83 or 84, the same level as Spring 2021, for the past three weeks.
The index’s measure of current sales conditions was flat at 90, while the six-month sales-expectations measurement dipped two points to 83. The buyer-traffic component fell two points to 69.
Regionally, the three-month moving average of the index slid one point in the Northeast to 73, while readings in the Midwest. South and West each rose one point to 75, 88 and 88, respectively.
“Higher material costs and lack of availability are adding weeks to typical single-family construction times,” NAHB Chairman Chuck Fowke said in a press release. “While lean existing-home inventory and solid buyer demand are supporting the need for new construction, the combination of ongoing increases for building materials, worsening skilled labor shortages and higher mortgage rates point to declines for housing affordability in 2022.”
The NAHB/Wells Fargo survey measures builder perceptions of current single-family home sales, as well as sales expectations for the next six months, as “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as “high to very high,” “average” or “low to very low.” The results are then used to calculate a seasonally adjusted index in which any number over 50 indicates that more builders view conditions as good than poor.
Updated: Boston Real Estate Blog 2022
Inflation and Boston Condo prices …
Inflation frightens most people because the cost of everything is going up. However, inflation has benefits for Boston condominium investors whether it is your primary residence or investment properties. That doesn’t mean a Boston real estate investment will help with the cost of gasoline and groceries today, but it can build long-term wealth. And… today offers a unique short-term window of opportunity for real estate investments.
As we all know, inflation decreases our ability to pay for goods and services when everything becomes more expensive. The basic concept is that when wages remain steady, but goods become more expensive, we can afford to purchase less. A primary driver of inflation is the basic “supply and demand” curve. As demand increases, prices also increase if there is not an excess of supply. Right now, demand is high because interest rates are low, which makes it less expensive for people to purchase everything they wanted. This is on top of the stimulus money that was pumped into the economy to stimulate demand. And it is all magnified by supply chain bottlenecks that have limited supply. High demand with limited supply is the perfect recipe for inflation.
The most useful tool the Federal Reserve has for controlling inflation is higher interest rates. This is key to the unique window of opportunity that real estate currently has in this time of inflation.
Specific to downtown Boston condos for sale, inflation is going to drive both higher mortgage rates and higher property values. Even if the pace of Boston high rise condo construction picks up, new construction (supply) will be more expensive due to inflation. This may all sound like unwelcome news for both buying Boston condo as a primary residence or expanding an investment portfolio. And it probably will be once the higher interest rates kick in. However, inflation is a borrower’s best friend and a debtor’s worst enemy. Hence, a short-term window of opportunity exists while interest rates remain low but inflation is high.
Inflation will be driving up property values, but today’s low-interest rates will become cheap money as long-term debt is devalued due to future inflation.
Inflation will accelerate the rise of Boston condo prices for sale, but the decreasing loan-to-value of mortgage debt is a natural discount. This happens because the equity in the property increases while your fixed-rate mortgage payments remain the same. This is a natural occurrence with most mortgages, and it becomes exaggerated in a good way when interest rates are low with a high inflation rate. An example of a natural occurrence is a $200,000 Boston condo for sale that was purchased 10 years ago with a 30-year mortgage and a corresponding $470 monthly payment. Today, that home is probably worth $460,000 but the payments will remain the same for another 20 years. In comparison, a person paying $460,000 for a home today will have a mortgage payment of $1,850. Everything else being equal, inflation has put an extra money in the pocket of yesterday’s homebuyer every month in comparison with today’s buyer (or $14,160 every year). An amount of money that will continue increase for the next 20 years until the mortgage is paid off in full.
However, everything being equal would require that tomorrow’s mortgage rates remain as low as today’s. Locking in today’s low-interest rates (before they go up) is going to amplify that inflation-beating rate of return. It gets even better…
Borrowing money is about using other people’s money to build wealth. A mortgage is other people’s money. When you put down only 15% to buy a property, you get a return not just on that 15% but also the other 85% because of appreciation. We don’t know exactly what the rate of appreciation and inflation will be, but historically these are close to 5% for appreciation and 2% for inflation. The difference in those numbers is key to building wealth with other people’s money.
For example, if you put down $50,000 on a $330,000 house, the appreciation over 20 years will give it a value of about $876,000. If you subtract out the loss of value due to inflation, that $330,000 home will be worth about $471,000 in today’s dollars. Your net gain will be $141,000 in 20 years. That’s for a primary homeowner. For investors with a rental house, the wealth multiplier becomes much more substantial. Investors will earn the appreciated value along with 20 years of cash flow to pay off the $330,000 mortgage, plus rent increases will cancel out the effect of inflation. Essentially, an investor can expect that $50,000 to obtain the full $876,000 over 20 years.
Today’s low-interest rates will further amplify the down payment multiplier. Real estate is one of the very few places where you can lock in a 30-year interest rate. Next month (or next year), the interest rate will be higher to compensate lenders for the rate of inflation. A higher interest rate means higher monthly payments which will reduce your total gain over the next 20 years. You’ll gain all the appreciation but less of the inflation multiplier.
The way you maximize the inflation edge today is by locking in a low mortgage rate for the next 30 years before interest rates rise.
Many people see building wealth as adding to their savings account or 401k retirement account. But these are highly susceptible to inflation and are slow to grow. Two factors have the biggest effect on this slow growth. First, neither of these accounts increases in value due to appreciation. So that entire segment of growth is wiped out compared to real estate.
Next, banks don’t pay saving accounts more interest than what they loan money for, or they would go out of business. Regardless of the inflation rate, you aren’t likely to earn more than about 0.06% on savings before inflation. When inflation is included, you’ll lose money overall.
With a 401k, it’s reasonable to expect an annual return of 6% – 7%. That will earn you an accumulative rate of return between 3.5% – 4.5% against a historic 2.5% inflation rate. But there is a kicker to that. That is only on the money you have in the investment. With real estate, you only need to make a small down payment to earn 100% of the profit. That means 85% of real estate earnings come from other people’s money. For example, a $50,000 investment in a 401k at 7% would become $193,000 in 20 years. By using other people’s money to invest the same $50,000 in a $330,000 house, that $50,000 can be expected to become $471,000 (or $876,000) in 20 years.
Bottom line, high rates of inflation and appreciation are beneficial for property owners. But today’s limited window of opportunity is locking in a low mortgage before inflation leads to higher interest rates.
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Inflation and Boston Condo prices ..
Boston condo prices tend to rise with inflation. Absent economic and supply-and-demand pressures, the price of goods remains the same. … But when the influence of other factors is small, more money moving around more quickly will increase the price of nearly everything, including housing prices.
In the real economy, there are a lot more factors that affect house prices and the correlation is not as prominent as in our example. One of the other major factors causing house prices to increase is interest rates. When interest rates are low, buying homes can be more affordable and increase the demand for homes. If the supply of homes remains constant and the demand increases, then the prices of homes will increase. In large cities where land availability is often limited, you can see a more pronounced effect of inflation. (For more related reading, see: The Truth About Real Estate Prices.)
Inflation and Boston Condo prices ..
I just read an article in Fortune magazine where the reporter was interviewing Mohamed El-Erain, who has earned his status as one of the investment world’s rock stars.
Here’s an excerpt:
What makes you confident that inflation will be coming back soon?
We’re looking at a world where not only is demand going to pick up, but there’s also going to be a lot of supply disruption. The old normal was a world where credit was freely available. Well, credit will no longer be easy. So we’re going to have demand picking up, and we’ll also have supply coming down.
My thoughts on the above comments and how it could apply to the Boston condo market. We’re looking at a market where demand will pick up as more and more “echo boomers” and “empty nesters” enter the Boston condo market but, access to credit to condo developers will no longer be easy, so supply will be coming down. For example, think about the big hole in the ground in Downtown Crossing. Developers can’t get credit to start the condo project.
The second part of Mohamed El-Erain answer on inflation
So you think, okay, there’s a recession going on – I should be able to buy a plane ticket cheaply. And initially you can. Then suddenly they take a lot of planes out and park them in the desert. They take the supply out, and you get inflation coming back…(without the liquidity in the market) at some point we’re going to face an inflation risk, and most people are not prepared for that.
My thoughts on the above comments: Can you see the comparison between the plane ticket scenario compared to the Boston condo market? Or do you think this is too much of a stretch?