Credit: Still, www.nme.com
If you are reading this letter, chances are you’re probably not a regular TikTok user. Therefore you might not have seen Nathan Apodaca’s TikTok video that went viral, causing tribute videos by the likes of Mick Fleetwood and a TV commercial. In the seemingly innocuous video, he is seen in the morning riding his longboard, drinking from a bottle of Ocean Spray juice. Why he is longboarding? His truck broke and he needed to get to work.
Apodaca is an hourly worker in a potato factory in Idaho Falls. He lives in an RV with his two kids and has no running water, so they shower at his brother’s house nearby. After the video’s popularity Ocean Spray gave him a brand-new truck, filling the bed with cartons of juice. On top of that he has received an outpouring of fan donations, with which he is hoping to buy a house.
On the opposite end of the spectrum, we have a real estate market here in Denver that is literally out of control. There has been no end to people gobbling up property. It is one of the tightest markets ever. For the last two months, more homes have sold than were for sale, leaving an even more depleted active inventory of homes. This activity has lead to ever-increasing prices.
Why in the world are all these people paying near-record prices for homes?
Here are some of the answers given by pundits:
My gut feeling is that all of the aforementioned reasons are true. In terms of net migration into the state this year, that data doesn’t come out until long after it has happened – so we’re just guessing (although it really does feel that net migration is high). In all honesty, there is no denying that record low interest rates are a significant factor.
- Low interest rates
- Companies and jobs moving to the Front Range
- People leaving high cost, dense cities like New York and San Francisco and moving to Colorado
- Pandemic preferences: people moving sideways/up/down to accommodate current realities for working and schooling from home
Yes, last quarter I said interest rates don’t drive demand. However, getting an interest rate in the mid to high two percent range? That seems too impossible to be true, and people are taking advantage of those rates. I believe some of what is driving people’s behavior is fear of missing out: “I don’t want to miss these rates! Everyone else is buying homes, I should too!”
That thinking can be misguided. Everything seems rosy when rates and inventory are low. What happens if rates go back up to the 4% to 5% range, which is pretty much where they have been for the last 15 years? Affordability plummets. Affordability affects demand. Lack of demand leads to increased supply, too much supply leads to declining prices.
Remember, 1% of interest rate is approximately equal to 10% of purchase price in terms of a buyer’s monthly payment. A $400,000 mortgage at 2.75% comes out to roughly $1,633 per month (principal & interest). The same mortgage amount at 5% is $2,147. That is a 31.4% increase in a buyer’s monthly cost.
So, let’s pretend home prices go up 12.5% from this year into 2021, and interest rates jump to 5% over the next 12 months. Next October the cost of buying a home will have gone up 43.9%! How many people will have experienced a 44% income increase over that period?
By the way, that’s on top of the more than doubling in housing prices over the last 11 years. The median price of a single-family home in the Denver metro area has increased from just over $200,000 in 2009 to just under $500,000 in 2020 (Source: Colorado Association of REALTORS®).
Going back to Nathan Apodaca – there is a wide income gap between someone like Nathan and someone currently buying a home in the Front Range. How many people are here like Nathan, employed but living in a home with limited amenities (or bunked up with family/friends)? What chance does someone have of buying a home within the 470 highway that surrounds the greater Denver area?
I am not saying everyone should be able to buy a home. I am not saying people shouldn’t be buying or selling right now. What comes to mind is Warren Buffett’s infamous quote, “be fearful when others are greedy, and greedy when others are fearful.”
There are some valid reasons for moving right now, but there is also mounting evidence for caution.