Appraiser's Perspective: Higher interest rates and property valuesCharlie W. Elliott Jr., MAI, SRAInterest rates,property appraisals
Is it finally over? Is that real estate boom, which began years
ago, beginning to wind down for sure this time? When compared to
the stock market bottoming out a few years ago, how long will it
take for the real estate market to finally hit bottom after a
number of years of record sales?
I will suggest that real estate cycles are much like our general
economy, in that by design, they fluctuate up and down with the
forces of the market. We never know when we have actually hit
bottom until we have enough data to plot an historic trend.
One thing is for sure—the market has remained resilient
thus far. Given where we have been, there is plenty of room for a
significant correction. Major cities in California, Florida and
Nevada, to mention a few, have experienced annual appreciation
exceeding 20 percent per year in recent years. Some have enjoyed
gains averaging in excess of 20 percent per year in home values for
the past five years. That being said, some areas such as Texas,
Georgia and North Carolina have not experienced such rapid rate
increases, reflecting only single digit increases. Many of these
communities just barely reflect positive annual increases,
reporting increases of around two or three percent per year.
It seems that many of us who are dependant upon the industry
have had our best years recently. So far, there have been few hard
indications of a topping out of the market, as most indicators have
been mixed. But deep down, we all know that as interest rates
increase, property values will be squeezed.
We hear a lot about our free economy and how prices are
determined in our country by supply and demand. That is true, but
only to a point. We all know that for many of the working years of
our lives, a man by the name of Alan Greenspan has been behind the
curtain, pushing the interest rate buttons. When interest rates
started up a few months ago, there were those who predicted that a
drop in property values would take place akin to an automobile
falling off a cliff. So far, that has not happened; however, it
should be noted that rates are likely to continue on an upward
spiral for the near future, as the Federal Reserve shows no sign of
loosening up. We can also credit Mr. Greenspan and his fellow board
members for letting us down easy by raising the rates just a
quarter of a point at a time, which has happened regularly over the
past few months.
Some say that we are perhaps likely to receive as many as eight
additional quarterly increases, or about two whole points, over the
next few months. Since the Fed bases its decision on the overall
economy and not just the real estate market, can the real estate
industry maintain its market position with such increases? Do we
even know where we are? Are we at the edge of a steep rocky cliff,
or are we just peeking over the top of a hill, looking at a
smoothly paved, gradually sloping street?
Now that we are here, wherever we are, most would agree that we
are likely to experience a dip in market values due to these rate
hikes. What circumstances and issues must we expect from those
people whom we have a love/hate relationship with—the
appraisers? Listed below are a few of the more obvious ones that
come to mind.
1. When mortgage rates rise, property values level off or, in
some cases, decline, especially after a sustained period of steady
increases. Do not be surprised to see this happen, especially in
some of your higher-priced markets mentioned above. In real estate,
what goes up too high, too fast, must come down. You may hear
statements, like, "I paid more than that for the property two years
ago," "Property in this neighborhood has always gone up in value in
the past. Let's get another appraisal," or, "It was appraised a
year ago for more than that. Does this appraiser not know what he
2. You probably have clients who seem to need to get a new
mortgage every year or so in an attempt to extract equity from that
one most important investment the average person has—his
home. Here, we are talking about the people who spend more money
than they earn. To stay afloat, they depend upon appreciation from
the value of their homes. When the market tanks, many of these
people will not be able to get a loan; that is, unless they switch
to one of those 125 percent loan-to-value mortgages, and chances
are that these types of borrowers maxed out in this regard the last
time they refinanced. The appraiser probably cannot help you on
3. What properties are the most likely to dip in value?
Everything else being equal, the properties that increased the most
in value in recent years are more likely to decrease under interest
rate pressure. This is particularly the case where there is
speculation driving up the prices of homes. An example would be a
condominium building at the beach, where buyers consider themselves
investors, hoping to flip the property at or before closing. These
properties generally are rental properties, although some are
second homes. If the economy tanks, rents will suffer, and that
will not help. Second homes come with their own set of issues.
Also, unlike other segments of our industry, the speculative
property area tends to drop in price faster and could fall prey to
the falling-off-the-cliff theory.
Those listed above are only a few of the circumstances and
issues that tend to crop up when interest rates squeeze property
values. As an appraiser, my advice to the lending officer that is
taking a loan application where property value decreases are
suspected is to order the appraisal early on. This could save both
time and money for the lender as well as the owner.
Charlie W. Elliott Jr., MAI, SRA is president of Elliott
& Company Appraisers, a national real estate appraisal company.
He can be reached at (800) 854-5889, [email protected]
through the company's Web site at