Waiting to Buy Could Cost You More

While the  prices of real estate have declined across the nation in the past year—albeit at varying levels, there is some sense that we may be getting close to a bottom in the market. Certainly in the islands and on the mainland there has been a pickup in sales volume. According to the  Case-Shiller Home Price Index, the national price declines range from as little as 4.9 percent (Dallas, Texas) on a year-over-year basis in January to as great as 35 percent (Phoenix, AZ) .

Many of the buyers that I have the pleasure of  meeting in Open Houses and through correspondence on the internet (such as Twitter) are anticipating  further price decreases. This keeps these buyers on the  sidelines  despite the lowest interest rates since Freddie Mac started tracking rates  around 1971.

While prices may continue to go down, the likelihood of rising interest rates could make purchasing Hawaii property now a better option than waiting for further (potential) value declines.  Simply stated, there is a very high possibility of interest rate increases.  Even with the prices continuing to adjust, the interest rate increase may result in buyers  no longer being able to qualify for a loan on a home they wish to purchase.  With the rates where they are now,  those same buyers are more likely to be able to qualify today.  So, despite the potential in declining property values, now may be a better time to buy.

Assume a loan amount today of $100,000 with a 30-year fixed-rate residential loan at 5 percent.  At the start of April,  the average 30-year rate was 4.85 percent per Freddie Mac.  Fannie Mae forecasts an average rate in all of 2009 of 5.13 percent.  So it would be reasonable to assume an average rate of 5%

The following table shows the monthly payment for each loan amount and interest rate.  A buyer today at 5 percent interest borrowing $100,000 has a monthly principle and interest payment of $536.82.  If prices decline 5 percent (and the loan amount does also) and interest rates rise just ½ of 1 percent, then the monthly payment remains the same ($539.40).

So if rates go up just 1 percent to 6 percent per year, then prices must drop at least 10 percent for that same buyer to qualify for the same monthly payment.  A 1.5 percent increase in rates to 6.5 percent requires a 15 percent price decline, and a 2 percent increase necessitates a 20 percent price decline to qualify.

As prices decline so does the down payment, at the same loan-to-value ratio.  Many  buyers select the price range of homes they look for based on their monthly payment potential… similar to how most people shop for a car. So rising rates may force these  buyers into less expensive homes and hence properties they find less desirable.

The Aggregate 20-city prices have already declined 29.1 percent since peaking in July 2006. On our island we have a lot of micro-markets. Any given neighborhood has it own level of rise and fall. For example, at  some condo complexes in Princeville, prices have adjusted by as much as 40% from their peak in 2006-2007.  And yet in Poipu, many condo complexes have only adjusted 20%.

Why do folks in our industry  anticipate rate increases?  There are several reasons.  Interest rates are the lowest in recorded history.  Most importantl though is the record deficit spending by Congress and the Administration and the general expectation for that trend to continue.  Borrowing a couple of trillion dollars this year coupled with a now-projected decade of deficits of at least $1 trillion per year sets the stage for a weakened dollar and corresponding rising interest rates. In plain English —massive deficit spending has a high potential to drive up inflation and hence interest rates.

Additionally, in this buyer’s market, you may find that you are able to purchase at a price somewhat below the already reduced asking price. When you consider all the factors at play, the opportunity for purchasing property on the island of Kauai may be now. If you happen to be an all cash buyer, then some of the variables discussed here may not have as much significance to you. However, if you are going to secure a loan for your property on Hawaii, the simple economics of the home values and the interest rates make a compelling case.

I can assist you in finding value here on Kauai. If you want to analyze the cash flow or rate of return for an investment, I can provide you with detailed market information to consider.