Interest rates are rising and home prices are seeing double-digit increases on a national basis, making it clear that real estate is entering a different phase from what we’ve seen in the past several years, when the market was all about recovery from the downturn.
Given these new dynamics, REALTOR® Magazine conducted a Q&A with J. Lennox Scott, chairman and CEO of brokerage giant John L. Scott Real Estate, based in Seattle, to get his views on where the market is now and what to expect in the months ahead. Scott’s company is among the largest in the industry, according to RIS Media’s 2013 Power Broker Report, with $3.8 billion in sales volume in 11,833 transactions by 1,078 sales associates in 31 offices. Those figures are for company-owned offices. When affiliate network offices are included, the volume is more than $7 billion in 27,000 transactions at 110 offices.
Scott’s view is that, against the rise in interest rates and the continuing strong appreciation nationally, the industry is settling in for a period of long-term stability.
REALTOR® Magazine: You say the market is transitioning to a healthy, sustainable phase, even though interest rates are rising, prices are seeing double-digit increases, and credit underwriting remains tight. Why do you say that?
J. Lennox Scott: It’s true markets are facing challenges. In addition to the three you mentioned, you can add as challenges continuing tight inventories and a drop in the activity of investors, who were so critical to the recovery right after the downturn. But we also have healthy fundamentals, particularly with job growth increasing. So, as long as we can count on continuing improvement in the fundamentals, we’ll see a smooth transition to a long-term, sustainable market.
RM: What could derail the fundamentals?
JLS: Well, action by the federal government, for one thing. What we need more than anything, in addition to improvements in the jobs picture, is the continued availability of safe, affordable mortgage financing. So, how the federal government reforms Fannie Mae and Freddie Mac, what it does with the qualified mortgage (QM) rules that are coming out next year, and what it does to FHA, VA, and federal rural housing down payment requirements, is critical.
On these issues, we need to keep low down payment requirements for FHA, VA, and the other federal loan programs and not overreact to the loose standards half a dozen years ago that led us to the financial crisis. Remember, it wasn’t low down payments that created the bad loans; it was lax underwriting standards. That problem is now fixed; the bad exotic mortgages for people who shouldn’t get them are gone, and the newest vintages of mortgages are performing well. So, we need to keep down payments low—3.5 percent on FHA loans, for example—to enable responsible households to overcome the down payment hurdle and become home owners. And we need to dial back credit standards to normal—where they were before lenders overly relaxed them during the boom. Lastly, the federal government has to get Fannie and Freddie reform right, because they’re the reason we have affordable, 30-year mortgage financing.
RM: You mentioned fundamentals. What besides job growth is healthy now?
JLS: Household formation is picking up again. That’s key for future first-time home purchases. FHA, VA, and other federally backed loans, including rural housing loans, still have low down payments. And, thanks to rising prices, more owners are no longer underwater, so they’re in a position to sell if they want. That helps create more inventory and more buyers.
RM: Given these improving fundamentals, is it a good time to buy?
JLS: If you’re selling but not planning to buy another property, then whether to sell now will depend on a few factors. You’ll want to watch your local market inventory. If it’s low, supply will be constrained and prices will head up. The tighter the inventory, the stronger the price growth. So, you might want to wait.
If you’re selling and also plan a move-up purchase, interest rates will be a key factor. If inventory is tight, prices will go up, both on the house you’re selling and on the one you want to buy. So, where interest rates are could be a deciding factor. You might want to buy soon, before rates go up much more. As a general rule, for every 50-basis point-increase in rates, you lose 5 percent of your purchasing power.
RM: So, bottom line, you’re saying the recovery phase of the real estate market is ending, market fundamentals are strengthening, and despite raising rates, the market is entering a long-term, sustainable phase and will stay there as long as the fundamentals, led by job growth and household formation, stay strong and the federal government doesn’t derail things by getting QM, Fannie and Freddie reform,, and FHA reform wrong.
JLS: That’s right.
For a bit more detail on Scott’s views about how the latest market dynamics affect long-term sales trends, click on the chart below.