US Median House Prices Fall

[Kontiki]

I think you're ignoring the demand side of the equation. A longer period of low rates mean progressively more people can move into purchasing as their own financial situation improves - use yourself as an example. New supply is not nearly keeping up with the demand, so as more people enter the market, it continues to drive up the cost. So it's not the interest rates themselves that continue to drive up house values, but they are a main contributing factor to increased demand.

[Colonâ„¢]

KH, you seem to say x decrease of interest rate = y increase of price. This could be correct, at any given time. However, when we're looking at changes over time, then the correct relationship would rather be x decrease of interest rate = y increase of the rate of price change.
What you are arguing is akin to arguing that when, without external factors, the fed stops changing interest rates there would eventually be price stability. The fed wouldn't need to raise rates when the economy overheats because it would fizzle out on its own.

[KrazyHorse]

Originally posted by Kontiki
I think you're ignoring the demand side of the equation. A longer period of low rates mean progressively more people can move into purchasing as their own financial situation improves

Huh?

[Kontiki]

Originally posted by KrazyHorse


Huh?

In short, prolonged low interest rates results in greater demand over time, not just as a one time occurance. Like Colon said.

[KrazyHorse]

Originally posted by Colonâ„¢
the correct relationship would rather be x decrease of interest rate = y increase of the rate of price change

That is wrong, wrong, wrong.

The reason a decrease in interest rates adds value to a home is that, given the same monthly payment it is possible to pay off a larger debt in the same amount of time (since less of the payment goes to interest on the principle.

Now, say that we have two different situations: one in which the interest rate on a 30 year fixed mortgage is at 8% for this year, then at 5% for the next 9 years, the other in which the interest rate is at 8% for the next 9 years and then goes to 5% during the 10th year. In both cases we look at the value of a given home now and in ten years time. From a purely micro perspective on interest rates (in other words assuming that income and population growth are equivalent in both cases).

At time t = 0, the market conditions are equivalent. It's the same home in the same market, so the price in both cases is X.

At time t = 10 years, the market conditions are again equivalent. There has been the same wage and population growth and interest rates are the same going forward from here. The house is again the same, so the price in both cases is Y. The fact that one market experienced low interest rates for a longer time doesn't mean ****. They both experienced the same price increase in the same amount of time, so the growth rate in both cases was the same. If I'm wrong then you have to tell me what it is in case 1 which causes a difference from case 2.

This means that interest rates provide a one time explanation for price increases. Continued low interest rates does not, by itself, explain continued high growth rates for housing prices.

[KrazyHorse]

To first order, the price of a house can be described as

P(t) = f(I(t))*Q(t)

P(t) is the price
Q(t) is the hypothetical price in a given market at a set interest rate
I(t) is the interest rate
f(I) is a correction factor based on the interest rate. Low I = high f

[Cort Haus]

The boom & crash of the UK housing market in the late 80's was at a time of high interest rates, ISTR.

So how does that fit the low interest= high prices rule?

Also, I don't see why the supply and demand of housing stock isn't being seen as much of a factor. It is a big factor, from where I'm sitting.

[KrazyHorse]

Originally posted by Cort Haus
The boom & crash of the UK housing market in the late 80's was at a time of high interest rates, ISTR.

So how does that fit the low interest= high prices rule?

Lower interest = higher prices generally. Doesn't mean there's a 1-1 correspondence. There's a whole lot of other factors which I put into the Q(t) term. other important factors are population&wage growth and the pace of new housing starts (though this one tends to self-correct)

[Cort Haus]

Originally posted by KrazyHorse
...pace of new housing starts (though this one tends to self-correct)

I'm not sure if I understand this. My point is that the free market does not operate in the UK because of heavy distortions on the supply side because greenfield developments are for the most part prohibited.

[KrazyHorse]

Uhhhh....okay. So?

[Cort Haus]

So the pace of new housing starts (if that means new developments) does not self correct as it would in a free market, because there is no free market.

[DanS]

Originally posted by KrazyHorse
Lower interest = higher prices generally. Doesn't mean there's a 1-1 correspondence. There's a whole lot of other factors which I put into the Q(t) term. other important factors are population&wage growth and the pace of new housing starts (though this one tends to self-correct)

Normally what happens is that it takes some time for the market to adjust to the new interest rates. Sometimes this adjustment period lasts many years (sometimes decades). So your comment about a one-time impact versus an ongoing impact seems like an academic exercise to me.

[KrazyHorse]

As I mentioned earlier, the fact that people are (were) driving housing increases by the growth of longer-term and creative financing options implies that there was more going on than simply long-term adjustment to low rates.

If prices were simply climbing slowly to their equilibrium at the new, low interest rates then there would be no need for people to finance housing on longer amortization terms (or 0 amortization or negative amortization). Therefore we may conclude that housing prices continued to climb above their equilibrium level.

Why?

[Kontiki]

Re-fi makes for cheap money with low rates - even cheaper if you push the amortization out as far as possible. That's the part that fuels the consumption boom. There's also the continued upward pressure on prices as demand increases, partially offsetting the lower rates.

[DanS]

Originally posted by KrazyHorse
As I mentioned earlier, the fact that people are (were) driving housing increases by the growth of longer-term and creative financing options implies that there was more going on than simply long-term adjustment to low rates.

If prices were simply climbing slowly to their equilibrium at the new, low interest rates then there would be no need for people to finance housing on longer amortization terms (or 0 amortization or negative amortization). Therefore we may conclude that housing prices continued to climb above their equilibrium level.

Why?

People finance on longer amortization terms for lots of reasons beyond trying to fit into a house that they can't afford otherwise. For one, it makes a lot of sense to decrease your carrying costs on a near-perpetual asset like a house and the land underneath it.

But in any event, I don't know how you would quantify the impact of these longer term loans on prices. Maybe these loans have a very small impact in the aggregate. F.e., the difference in monthly carrying costs on a 30-year loan versus an interest-only loan isn't as large as you might think. But we know for sure that interest rates declining has had an impact on all loans and asset decisions in an overwhelming way.