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By Connor P. Wallmark • Dec 31st, 2009 • Category: first tuesday blogs the news
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The Federal Reserve (the Fed) has taken aggressive steps during 2009 to drive mortgage rates down in order to encourage more people to buy homes and revive the real estate industry. The Fed lowers interest rates by purchasing large quantities of mortgage-backed bonds (MBBs) packaged and sold as investments by Freddie Mac and Fannie Mae (themselves taken over by the federal government in September 2008). This program, started last year, immediately pulled interest rates well below 6% and made highly advantageous financing available to well-qualified borrowers, spurring real estate activity. The steps coincided with massive buyer, builder and mortgage lender subsidies from the Treasury to clear out new homes and real estate owned (REO) inventory.

However, the Fed will start winding down its MBB purchase program early in 2010 by purchasing fewer of these MBBs. For the MBB market to continue to sell off its bonds, more private investors will need to re-enter the market since they have been largely absent due to the low rates set by the Fed purchases during 2009. The reason: private investors generally require a higher yield on their MBBs than the Fed set during 2009, which will necessarily require mortgage lenders to raise the interest rates they charge homebuyers.

An increase in interest rates will eliminate many potential homebuyers, unless sellers and their listing agents are willing to reduce the prices they demand to reflect the reduced borrowing power caused by an increase in interest rates.

first tuesday take: A quick review covering how the Fed is able to lower interest rates by purchasing MBBs may be helpful. Typically, both the Fed and private investors purchase MMBs. As the Fed temporarily purchases larger quantities of MBBs at ever lower interest rate yields (artificially creating greater demand for lenders to obtain funds for mortgage lending), the price of MBBs increases. In lock-step response to the rise in the price paid by the Fed for MBBs, yields (reflected in the form of mortgage interest rates) fall. Thus, price and yield (interest rates) always move diametrically, much like the opposing sides of a teeter-totter.

The Fed’s program to lower interest rates has been nothing but successful. However, it cannot go on indefinitely and the Fed must start easing back before consumer and asset (real estate) price inflation become a real threat. While some may object to the personal impact of increased interest rates, they should also take solace in the fact that the Fed concludes the economy will soon be healthy enough to live without life support. [For more information regarding inflationary concerns in response to the Fed’s actions, see the November 2009 first tuesday blog, The Fed to the rescue – inflationary fears assuaged; see also the October 2009 first tuesday article, Fear mongers’ inflation prediction unjustifiable.]

A tip to first tuesday students: be sure to inform the buyers and prospective refinancers you represent that rates are expected to increase as soon as March 2010. Your clients would be wise to obtain financing now when rates are artificially low – before they begin their eventual upward ascent.

Re: “Freddie sees mortgage rates hitting 6% in 2010,” from the Washington Post

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Is China the future of real estate in California? A recent report in the International Property Journal anticipates a future surge in Chinese buyers. In Southern California, the report notes, Chinese language listings have already replaced Spanish as the most searched foreign language listings, and Chinese buyers made up 7.5% of international buyers in the United States in 2007. The reason for the anticipated rise? An increase in the value of China’s currency, and a rise in the number of wealthy Chinese citizens, coupled with a drop in home values in the US, makes good deals ever more available and tempting for international buyers.

first tuesday take: Brokers who want to court buyers from foreign markets would do best to find the foreign currencies that have gained the most value against the US dollar in the recent past. China’s treasury policies have deliberately kept the value of the Yuan Renminbi (RMB) artificially depressed, and it has gained literally nothing on the US dollar in years. On the other hand, Brazilian, Canadian, Europeans and many other international buyers have seen an increase in the value of their money, in that their currencies are now able to buy more US dollars than in the recent past. Brazil’s Real, for instance, has gone from four reais to the dollar to less than two to the dollar since 2002. With an appreciated foreign currency comes greater purchasing power for acquiring property in the United States than that of Americans holding US dollar. Thus, for those individuals holding Euros or any other strong currency, property in the USA is cheaper than comparable property in any other country with a strong currency.

For a foreigner using a strong currency to purchase real estate in California, the current Great Recession offers a double profit advantage that an American holding US dollars does not have. The Great Recession in the USA has further decreased the value of property in states like California. When a US dollar denominated property – such as California real estate – is acquired when its value is depressed, as is now being experienced in this recession, the buyer, whether an American using dollars he holds or a foreigner using dollars he has purchased, will take the same amount of profit on those dollars when they resell that property.

Now factor in the strengthening of the dollar in the foreign exchange markets, which will occur over the next several years as the US economy recovers from this recession (as appears to be happening as we write). On the resale of California property in a few years, the foreigner will convert his dollars from the sale (and pay the same profit taxes as an American) to the foreign currency he used to buy US dollars for the purchase of California real estate. The foreigner will then take an additional profit – the double profit advantage – on converting his then strong dollars into his weakened foreign currency. On the return of his US dollars to his foreign currency, after the adventure in California real estate, he will have profited both on the sale of the real estate and the sale of the US dollars. This would have been impossible if he had invested within his own country.

With a little research into currency exchange market activity, California brokers with contacts in countries with strong currencies compared to the US dollar can present their listings to foreign buyers as investments which will increase in value over the next several years in terms of their US dollar value. Then, as brokers should advise, foreign buyers may have the opportunity to take a further profit at the time of the eventual resale after the US dollar appreciates in the currency markets during the nation’s economic recovery. Curious and well-connected brokers and agents will reap the rewards.

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