Harry Salzman can barely keep up.
“I’ve been in residential real estate for 45 years this month and I’ve never seen things like this,” Salzman, a veteran Colorado Springs real estate broker, said weeks ago. “I can barely get a home in the $300,000-and-under range listed and it already has multiple offers, most at list price or over and with very few contingencies, and short turnaround times in many cases.”
Earlier this week, Salzman confirmed that the boom is still accelerating.
“You now have a phenomenon I’ve never seen,” he said. “People won’t put their houses on the market because they’re afraid they won’t be able to find a place to move to. And the market is moving so fast that appraisers can’t keep up — I almost lost three deals recently because the appraisals were below the sales price.”
So what has fueled this local buying frenzy? And what might cool off this possibly overheated market? Is it a classic case of supply and demand, with too many buyers chasing too few listings, or are there other factors in play?
Today’s dynamic real estate market — as well as the lively regional economy — is also driven by historically low interest rates. Mortgages, small business loans, credit cards and other consumer debt instruments are less expensive than during 2006-2007, the peak years of the last boom. Will rates remain low, or will they increase dramatically and send our economy back to the doldrums? And will projected increases in the Federal Reserve’s benchmark federal funds rate affect us?
According to the Federal Home Loan Mortgage Corporation (Freddie Mac), the monthly “average commitment rate” on 30-year fixed mortgages in March 2017 was 4.2 percent. In 2006-2007, rates were 50 percent higher, averaging 6.37 percent over the 24-month period. During that time, the federal funds rate averaged about 5.25 percent. As the Federal Reserve responded to the financial crisis and the Great Recession with drastic rate decreases, the rate bottomed out at 0.25 percent in 2009, where it stayed for six years.
The effective federal funds rate is “the rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight,” according to Investopedia. Earlier this week, the rate was 0.91 percent, on the high side of the Federal Reserve’s target rate of 0.75 — 1.00 percent following a March increase from 0.50 to 0.75 percent.
The Fed was created in response to the Panic of 1907, when a sudden bank run threatened major institutions. A consortium headed by J.P. Morgan provided liquidity and guarantees, averting a crisis. In 1913, the Federal Reserve was created to prevent further panics and stabilize the national economy. According to the Fed’s website, “The Federal Reserve is the central bank system of the United States that includes the Board of Governors in Washington, D.C., and 12 independent regional reserve banks. This decentralized structure ensures that the economic conditions of all areas of the country are taken into account in the making of monetary policy.”
Now the federal funds rate appears to be on the rise, amid predictions that the Fed plans three additional 0.25-percent increases during 2017.
The local impact
Will these increases affect local mortgage interest rates?
“That’s a common misconception,” said Colorado Springs financial advisor Allan Roth, “and one that is not only worthless but dangerous. It’s called following the crowd. No one can forecast rates. And as far as projected increases in the federal funds rate are concerned, the mortgage market has already adjusted to those. Ask 50 leading economists what the direction of interest rates are, and you’ll find that they’re evenly split. The world is a lot more unpredictable than we think. Look at Japan — the Central Bank there has been trying to stimulate the economy with low and even negative interest rates for decades, and it hasn’t worked.”
Roth pointed out that interest rates on various forms of credit are determined primarily by lender risk assessment. Small business lenders, mortgage lenders and credit card issuers use various metrics to calculate appropriate rates, and the federal funds rate is scarcely a blip on the radar screen.
“Default probability is the first one,” said Roth. “It doesn’t matter what rate you’re charging if your borrower defaults, so you have to adjust your rates accordingly. Credit card issuers will charge what the market can bear, and it’s ugly debt — the interest isn’t tax deductible.”
“The federal funds rate increases haven’t affected us so far,” said Pikes Peak National Bank president Robin Roberts. “But if it continues to go up it will affect what borrowers can qualify for. But the bottom line is that this is still a very competitive loan environment, and banks are very liquid. If you raise your rates in response to the Fed, you price yourself out of the market. The rates we pay depositors have remained low, so in this environment, banks make their money by doing loans.”
That’s good news for businesses large and small. Salzman said he doubts whether the Fed’s actions will have any impact on the regional economy, and cites yet another reason to be optimistic.
“El Paso County’s population increased by about 14,000 in 2015-2016,” he said. “We’re not adding enough housing to provide for that rate of annual increase, so that drives real estate prices. I don’t think we’ll see a slowdown.”
And although Roth makes no predictions, he pointed out that it’s easy to misunderstand interest rates.
“Back in the ’80s, you could get 12 percent on a certificate of deposit, and people loved it,” he said. “But after taxes and inflation, your real rate of return was -3 percent. You do better when inflation is 2 percent and your CD pays 3 percent — but most of us would rather have that high interest rate. We’re not always rational beings.”