Could Higher Rates Make it Easier to Buy a Home in Colorado?

Since December of 2021 to April 2022, 30 year fixed interest rates have risen from around 2.875%, to around 4.875%. That's a huge jump. At first glance this would appear to be a big disadvantage to home buyers. These higher rates mean the monthly payment on a $500,000 purchase, with 20% down, is now about $400 more expensive than before. 

Wow! That is quite a large increase for most people. But could there be a silver lining in this news? There are a few reasons buying a home in Colorado has been so challenging over the last few years:

-Low Supply and High Demand

Colorado has a net increase of 70,000 new residents moving to the state each year, but in 2021 26,636 new home permits were pulled. There is not a new home for every new resident (although the permits pulled in 2021 are an encouraging). According to the Denver Post Colorado is actually a top-ten US state for new permits pull compared to population https://www.denverpost.com/2021/07/23/colorado-homebuilding-permits/).

-Investors competing for homes

If you have been following the Colorado and national home market lately, you surely have heard that investors are using real estate to generate returns on their portfolios. This means Corporations, REITs, and Individual investors have been plowing money into the Colorado home market looking for high returns on investment properties and rents. This demand is competing directly with people who are looking to buy a home to live in.

Primary Residence, Second Home, Investment Property

In the mortgage world, we have pricing criteria for loans depending on their intended use. It can either be an investment property, a second home, or a primary residence. Why would a seller prefer to sell to an investor vs. someone using the home as their primary residence? Simply put, the investor often has a better offer. Investors have deep pockets and often can buy with cash. Primary Home buyers are often first-time buyers with special circumstances. Perhaps they only have 3% down, or they have a VA loan, or maybe they have lower credit scores, or maybe they are using a co-borrower. All of these factors for a Primary Residence home buyer might look worse than an investor who can pay cash and close quickly.

The Tables may be turning to Favor Primary Residence Buyers

But what kind of investment is real estate when rates rise? Is it as attractive? Let's take break down the investor market into two segments, corporate and individual.

Corporate Investors: Many of the corporate investors in real estate have seemingly unlimited funds to throw at properties. This is why they can buy all-cash. The "cash" they use is part of a bigger pool of holdings. But, for these investors, that holding often, ultimately does get financed. These institutional investors are often leveraging their very low borrowing costs to purchase properties. Even though corporate buyers don't use conventional mortgages, they do use funding of some sort. And when rates go up on mortgages, they are also rising elsewhere. Short story: borrowing costs are rising for corporate investors too.

Individual Investors: Many real estate investors buy properties one at a time. Recently they have poured their funds into the Colorado real estate market. Why? Because when rates are extremely low and rents are high, real estate can be a great investment. Someone who might have invested in their retirement account might decide that real estate is a better investment and choose to put their investment funds there. These investors are essentially choosing where to invest their money. Stocks, Bonds, Real Estate? And when rates are low Real Estate looks good.

Rates are Different for Investors: Did you know that pricing on mortgage rates is worse for investors? Yes, investment property mortgages are typically about 1/2 a percent worse on investment properties. With a smaller down payment the spread is even greater. Right now, investment property rates are in the mid 5's (04/11/2022). What are the consequences of this for investors? Well, it means the monthly payment on that property will be higher now than last year. This also means, from an investor's perspective, the rent on that property will need to increase enough to make up for the higher payment. What happens if the rent is less on an investment property than the payment? Well, the investor is losing money (at least on the cash flow). And losing money is not something investors like to do.

Changes on Second Home Pricing

Here's a little-publicized change that also increases rates on investors, and might decrease investor home-buying. In March 2022, all conventional loans changed their Loan Lever Price Adjustments (LLPA) to increase the "hits" on 2nd homes - to match investor properties. Prior to this change, someone buying a second home could buy a property with the same rates and fees as a primary residence - but no more. Now, if you want to buy a second home you pay higher rates, just like an investor.

Why did the Agencies do this? Because it is very common for second-home buyers to rent out their home part-time. In essence, home buyers were able to purchase a part-time investment property with primary residence pricing. Fannie Mae's primary directive is to increase home ownership, and mainly home ownership that you will live in. Fannie Mae and Freddie Mac want to incentivize primary residence home buying.

Finally, in the End, My Prediction

...Is, that investors will start being more selective about the homes they buy, and fewer people will be buying second homes. The supply and demand will slowly shift, and primary home-buyers, who get the best rates and the best deals, will have more options. This won't be a seismic shift, and it won't happen overnight. But as rate increases settle over the real estate market, the demand from investors and second-home buyers will decrease. This will naturally leave more supply for buyers of primary homes...even if it is at higher rates.