Real estate professionals generally prefer interest rates to stay low because they make mortgages more affordable for buyers. But there’s a larger picture to consider, according to a prominent economist.
The economy is doing well, but there’s a “correction” coming, likely after the inauguration of the next president in 2017, said Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley.
“I’m not saying a bubble burst, but a correction,” Rosen told attendees at the center’s annual conference yesterday.
The Federal Reserve has kept interest rates at rock bottom for several years as a way to pull the economy out of the Great Recession.
But that has created an “easy money” environment in which people are looking to stash their dough somewhere with more than a zero percent return, whether in the stock market, real estate, or in tech companies with skyrocketing — perhaps excessive — valuations.
In the booming San Francisco Bay Area, tech companies are “using capital to hire lots of people, but the bottom lines are very thin,” Rosen said.
“This is feeling more and more like that time [in 2007] when we had too much money chasing too few opportunities,” he added.
The longer it takes the Fed to raise rates, the more likely there is to be a bubble, Rosen said.
“I think everyone in real estate would like rates to remain low forever, but it actually isn’t a good thing,” he said.
Short-term interest rates currently sit at zero, but the Fed has said that they will go up to 3 or 3.5 percent over the next decade, according to Rosen. The question is when. Rosen believes it could be in September, or perhaps as soon as July.
“If I could waive a magic wand, I would make the federal funds rate 2 percent. Zero is the wrong number. It’s a mistake” when we’re at almost full employment, he said.
The U.S. unemployment rate stands at 5.4 percent. Full employment would be 5.1 percent, and we’ll be there by the end of the year, according to Rosen. For college graduates, the rate is already beyond that: 2.7 percent.
In much of the country, there is a shortage of qualified people, especially those with technical skills. That shortage will limit the nation’s job growth, according to Rosen. This year, jobs will grow by about 200,000 per month through the end of the year, he said — not bad, but less than last year’s rate.
Consumer confidence is up, but not evenly. Those on the higher end of the income spectrum are increasing their spending on luxury goods, but the lower end was hit harder by the recession and has not recovered as quickly.
Income inequality caused by education and the changing structure of the world economy will be the focus of the 2016 election, Rosen said.
The solution will be to put more effort into educating those in the bottom income quartile and their children, he added.
Gross domestic product will rise 2.3 percent this year, he predicted — just under last year’s 2.4 percent GDP growth.
“That’s about as much as the U.S. economy can grow. We can’t grow any more with our age structure,” Rosen said.
There is a huge cohort of aging and retiring baby boomers that will require more Social Security and Medicare spending. It’s going to be tough for three-quarters of the population to support the 25 percent that will need extensive services, Rosen said.
Another demographic group to keep in mind are millennials, he said. Young people are finally getting jobs and moving out of their parents’ homes, but they’re mainly becoming renters, not homeowners.
This is partly because millennials are delaying the kinds of household formation events that often trigger a home purchase (marriage, children) and partly because credit is too tight, according to Rosen.
The average monthly rent for an apartment in San Francisco now stands at $2,851 — a double-digit jump from a year ago. The rise in rents has led to a multifamily and commercial construction boom, particularly in the Bay Area where cranes appear to be ubiquitous.
But there is another effect as well: Millennials and other groups such as blacks and Latinos are being disproportionately shut out of homeownership, according to former Federal Housing Administration (FHA) Commissioner Carol Galante, now a professor at UC Berkeley.
“Fewer people are accessing homeownership. Fewer people are building wealth. That is a problem that we need to rectify,” Galante told conference attendees today.
One way to do it would be through less exclusionary mortgage lending standards, she said. Today there are 50 percent fewer loans being made to African-American households than there would be if credit standards were what they were in 2001, before the bubble, Galante said. For Latino families, that figure is 38 percent.
“We have a situation today where mortgage credit is very restrictive. I think that is not sustainable and it’s also not fair when you think about who is being hardest hit,” she said.
Today’s real estate boom in California and the Bay Area is different from the housing bubble of the mid-2000s, according to Galante.
“Irresponsible lending created that inflated situation,” she said.
It’s different today, when home prices are going up so high that they’re becoming unsustainable and people are beginning to feel shut out, she said.
It’s when people feel they’re being displaced that they start advocating for policies like rent control or a shutdown of new construction, according to Galante — those reactions will affect the real estate market.
Concerns over displacement and gentrification are not a reason to stop infill development or transit-oriented development, but there should be a way to take into account the people living in the area, she said.
As new properties are being developed or an area is improving, there should be a way these properties are acquired that will keep the rents in that neighborhood more affordable over the long term, perhaps through a nonprofit organization, she added.