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Price Is How Much You Pay

NY Times reporter, David Leonhardt, shares some interesting insight on the connection (or disconnect) between Mortgage Rates and Home Prices.

...
It’s not easy to see much of a relationship.
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My best guess for why the two don’t correlate more closely is the role that psychology plays in housing markets. Prices just don’t move as quickly as economic theory suggests they should.

Not really, David.

The market, for all it's recent folly, is a generally rational experience. And buyers, for all the talk of the "emotional purchase", make rational distinctions.  For instance: The price is how much I pay for a house. The interest rate is how much I pay for financing.

In today's REO (bank owned) driven market -- many buyers pay cash. Would a cash buyer pay more because interest rates are low?

Probably not, David.

It's true that low interest rates make buying a home more attractive than renting. It's also true when it's more attractive to buy (vs. rent)-- there is more demand for housing.  Supply/demand economics ensue.  But to the earlier distinction: A smart (rational) buyer will consider low rates are temporary and will rise in the future when they sell the property.  So for a theory such as low interest rates impacting price to run full course, it must be considered the price of a given home will decline in the future as interest rates rise. The result? The attractiveness of low interest rates in the present are cancelled out by the buyers rational predictin of higher interest rates in the future. A buyer who can take advantage of low interest rates today does not want to overpay for fear of high interest rates tomorrow.

At least that's why we "don't see much of a relationship" in the graph.

Discussion

#1 By Steve Baker at 12/23/2015 7:01 AM

Unfortunately, most buyers and sellers are not in touch with the term "price".
When someone asks what the "price" is, my response is whatever someone is willing to pay. Great topic-thanks.

#2 By Peter at 12/23/2015 7:01 AM

Can I just say its refreshing to see people in the real estate business talk in a way that interacts intelligently with economic theory. This site is an oasis of intelligence in an industry of robots trained to repeat "its a great time to buy" to whoever and in whatever context.

Really appreciate the thoughtfulness you guys put into your analysis.

#3 By Joshua Keen at 12/23/2015 7:01 AM

@ Peter -- I appreciate your comment. It's also refreshing to see people, like yourself, who appreciate the work we put into providing great content for our readers.

@ Steve -- I agree that price, as defined in the real estate industry, is what a given buyer is willing to pay. But have to disagree that most sellers and buyers are not in touch with the term "price". They (buyers and sellers of real estate) deserve more credit than that. After all ... it's the agreements between buyers and sellers (and their rational reactions to market forces) that create "price". At least that's what I'm arguing here.

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