The writer is a lawyer by training who deals with and is involved in technology. Lives in the US and manages a cryptocurrency investment fund. Author of the book A Brief History of Money, and podcaster KanAmerica.com on Twitter @ChananSteinhart
Since August 2021, the interest rate on mortgages in the US has increased by almost three times. For example, the one on a 30-year fixed mortgage jumped from about 2.6% in August 2021 to over 7% in October 2022. This dramatic increase not only increased the monthly repayment on mortgages New by 60% and more, but also affected the entire mortgage market.
According to the US Mortgage Bankers Association, the number of applications for new mortgages registered last week was 42% lower than last year and the demand for refinancing fell by 87%.
Also according to the Atom company from California, which collects data on the American real estate market, the mortgage market is in an avalanche. The number of new mortgages taken out in the third quarter of 2022 decreased by 19% compared to the second quarter of this year, and by 47% compared to the corresponding quarter in 2021 – the drop The biggest in 21 years. The volume of mortgages also fell by 46% compared to the same quarter last year – and this is also the biggest fall since 2001.
This trend led to an immediate crisis in the companies involved in issuing mortgages. Some of the biggest ones have already laid off 50% or more of their employees. Last week, Wells Fargo Bank, one of the leaders in the US mortgage market, announced that it has decided to significantly reduce all of its activities in the field. Instead of its previous plan to reach 40-50% of the market, it will completely stop providing mortgages to those who are no longer a client of the bank. In addition , the bank will sell billions of dollars from its mortgage portfolio and close the unit that gives credit to other companies engaged in providing mortgages.
$1.2 trillion in mortgages or atm
The weakening of the mortgage market will not only affect the real estate industry, which makes up about 16% of the US GDP, but also consumer spending in general.
In the US, there are several types of mortgages. The first is a mortgage that is taken out to purchase a house. Another type is a refinanced mortgage, that is, customers who refinance their existing mortgage in order to benefit from better interest and loan conditions. A third type of mortgage is taken out for the purpose of “drawing capital” (cash ־out refinance) accumulated in the house due to its increase in value. In the latter type, the customers take advantage of the increase in the value of the property to take out a new mortgage (larger than the existing one if there is one) and use the money for various consumption purposes. The value of all residential real estate in the US occupied by its owner In the first half of 2022 it stood at about 41 trillion dollars, an increase of almost 50% since 2020.
Since interest rates on mortgages were at historic lows, it would not be surprising that many in America turned their homes into a type of ATM, both through equity-type mortgages and as collateral for a line of credit. According to a study by JP Morgan, the average American who takes out mortgages in order to withdraw capital, increases his existing mortgage by about a third, extends its repayment period by about 6 years, and increases the monthly repayment by about 20%. According to a report published by the research department of Black Knight Inc., in 2021 mortgages were taken in a record amount of about 4.4 trillion dollars. Of the above total, 1.7 trillion was used to purchase new homes, and about 1.2 trillion was taken as capital withdrawal.
Where does all this money go? According to a study by the Federal Reserve, about a third finances renovations to the existing home, about a third goes to repaying debts that carry a higher interest rate or is used for investment, and about a third is used directly for private consumption that is not related to the home, such as a car and vacations. In a publication from last November, the economists of the Federal Bank estimated that the increase in the value of houses, and the sense of wealth and the accompanying capital attractiveness, led to an increase in consumption that was responsible for a third of the price increases in the last year. Considering the fact that in 2021 more than $4 trillion of mortgages per share flowed into the economy, it is easy to understand why the collapse of the mortgage market in general and the mortgages used to attract capital in particular, will have a significant impact on the economy beyond the real estate market itself.
The stagnation in the housing market is already here, and this is the next step
The real estate market is not as sophisticated as the stock or bond market. There is no continuous price disclosure, or uniformity and identity between the products themselves. For these reasons, the real estate market reacts slowly to changes in financing conditions.
The first stage is stagnation. Buyers adapt relatively quickly to the new interest rate, the monthly repayments they can afford, and the new price derived from it. But the sellers who got used to the old and high price, naturally refuse to put up with the new price. This is how the number of transactions decreased for 10 consecutive months. In November 2022, the volume of transactions fell by 7% compared to the previous month, and by 35.4% compared to November last year, according to the National Association of Real Estate Agents in the USA. Even the market for the most expensive homes, priced above $10 million, in New York and South Florida experienced sharp falls in the number of transactions. According to a year-end report by Serhunt, in the second half of 2022 the number of contracts signed for these luxury apartments in New York fell by 68%, and in Miami by about 60%.
The decrease in transactions obviously also affects the construction market, which experienced a large jump in the number of construction starts in the last two years when cheap money flowed into the industry. In March 2022, construction starts in the US reached an annual rate of 1.8 million housing units – a record not seen since 2006. By November, this number had dropped by 20% to approximately 1.4 million. Also the number of applications for building permits, which indicates what is expected to happen in the market In the near future, it fell by 11% at the end of 2022. According to the estimate of the mortgage giant, Fannie Mae, in 2023 the number of construction starts will be 1.1 million, a decrease of about 37% from the peak at the beginning of 2022.
The aftershocks of a break in the housing market will be severe
The breakdown in the market, the stagnation in deals, and the price drops that have already begun (in the San Francisco and Seattle area a 10% drop from the peak in prices was recorded), create additional difficulties, some of them even unexpected. Economist Or Shai, co-director of Flex Capital Group, which specializes in startups and real estate investments, explains that “given the enormous leverage in the real estate market, the borrowers are highly sensitive to financing costs and the flow of income.
“With the increase in interest rates, there is pressure on the real estate market from two directions: on the one hand, the banks demand that the ratio between the net operating profit from the property, and the total annual debt repayment for it, not fall below 120% and up to 160%, depending on the type of property and the level of risk attributed to him. (say for an annual debt repayment of 100 dollars they expect to see an annual net operating profit of 120-160 dollars – H.S.). At the same time, the loans given at a fixed interest rate and coming to an end, require renewal at the new, higher interest rate. In the next 36 months, hundreds of billions of dollars in loans are expected to come due and be replaced. According to the data company CRED, about 162 billion dollars of such loans are due to be repaid in 2023 alone, and they will have to renew the financing at the high interest rate, sometimes twice or more than the terms of the original loan.
Or Shay explains that the dramatic increase in financing expenses may undermine the companies’ ability to meet the return on income required by the banks. In addition, the decrease in yield on the property, due to the increase in financing expenses, reduces its balance sheet value, which also affects public companies and the value of bonds backed by assets. “In a study carried out by TREPP, a central platform in the field, it was found that if the interest rates on real estate debt on average reach 7%, the amount of stock market loans with a profit-to-income ratio lower than required will reach 12.3%, with a particularly great difficulty in the office and retail sectors” , He says. “At the same time as the increase in financing expenses, the operating profit may also suffer from the income side, especially if the level of economic activity slows down and rental prices fall.
Already today, according to the survey company that operates in the field, Commercial Edge, as of November 2022, rent prices for offices in the US have decreased by an average of 3.1% compared to 2021. The double pressure, both from the debt-to-income ratio and from the decrease in operating profit, will gradually bring to reality In which assets that are sensitive to the costs of debt or rent may find themselves in real financial distress.”
According to him, the first signs of these trends can already be seen today. “In San Francisco, for example, it was announced last week that a company called Veritas, the largest in the city in the field of residential properties, failed to pay its obligations on a loan amounting to 448 million dollars. While such pressures will continue to spread in 2023, it is likely that we will see attempts to raise funds to get rid of properties at prices much lower than those in 2021.” .
Investors should remember not to fight the Fed
Since 2008 we live in a strange world like no other. Since the founding of the republic 250 years ago, until 2008, interest rates in America have never been at or close to zero, and in the 60 years prior to 2005, the average basic interest rate (FFR) was close to 6%. Since the Fed was founded, in 1914, until 2005, the Fed did not finance the government debt in significant amounts, but at the beginning of 2023 this financing stood at 6.2 trillion dollars. The Fed has also never bought or financed mortgages issued to residents, but it is starting the new year with about $2.3 trillion in financing (including more than a fifth of the mortgages issued since 2020).
Jerome Powell, Chairman of the Federal Reserve / Photo: Associated Press
It would not be an exaggeration to say that today in America (and in the whole world) there is no real free economy built on production, supply and demand, which stand on their own and are driven by consumers and suppliers. Since the beginning of this century, there is only one factor that dictates prices, creates tides, brings booms in the stock market, but also creates periods of recession and depression – this is the Federal Reserve. At his will he prints and expands, and at his will he reduces the money supply and with it the economy and all the markets. With a mortgage debt hump of nearly $20 trillion by the end of 2022, only one thing will determine what the real estate market will look like in the next two years. The interest rate policy of the Federal Reserve and the amount of money they will print directly into this market through purchases of the Federal Reserve.
Therefore, it is worth listening carefully to what Chairman Powell repeated many times, and most recently at a conference in Stockholm: “Price stability is the basis of the entire economy… This may require unpopular measures when we are raising interest rates in order to slow down the economy.” The employment report for the month of December, in which An addition of 223,000 vacancies was reported and the unemployment rate fell to a historic low of 3.5%, showing that this slowdown is still a long way off. In the struggle between the markets, and especially the stock market – which refuse to believe Powell – and the Federal Reserve, it is better to remember the investor’s golden advice to investors again The legendary Professor Martin Zweig (1970) “Don’t fight the Fed” – “Don’t fight the Fed”.