August RIA Roundup: The Mortgage Lock-In Effect
The RIA Roundup is a monthly real estate newsletter with the latest stories, data, and insights curated especially for rental property investors.
In this issue:
Lead Story: The Mortgage Lock-In Effect
Portfolio Updates
In Other News…
Final Thoughts: Work / Life
Lead Story: The Mortgage Lock-In Effect
When buyers get into contract on a property, they often want to “lock in” their mortgage rate through the closing. That way, if rates happen to float higher between contract and closing, they won’t be subject to the higher rates. (Luckily, if rates go lower, buyers generally will get those lower rates at closing — so it’s basically a “heads I win, tails you lose” situation.)
But there’s an entirely different kind of mortgage “lock in” effect happening right now, the force of which is so powerful that it’s warping the housing market and creating market dynamics that we haven’t seen in at least 40 years — if ever.
What could this all-powerful force be? It’s the unwillingness of homeowners who have low mortgage rates — and that’s most of them — to list their homes for sale. Their conundrum is this: why give up a 3.5% mortgage on your current house if the mortgage on your new house will be 7%? Especially if that higher interest rate means you can’t afford to “trade up” into a better home anyway?
Let’s review some data that helps tell this story. First, here’s a look at mortgage rates over the last 10 years, which show the big jump in rates over the last 18 months:
Actually, we could go all the way back to 2002 before we find mortgage rates as high as they currently are. This means that the vast majority of homeowners have mortgages with better rates than they could find in the market today — either because they initiated their loan at a lower rate, or they subsequently took advantage of rock-bottom rates to refinance their loan.
And when I say “vast majority”, I really mean it: more than 90% of outstanding mortgages are below 6%, and 62% are below 4%. This chart illustrates those figures over time — check out the flurry of refinancing activity during 2020 and 2021 when a huge number of homeowners locked in rates below 4%, and even below 3%:
So for all those people, there is a strong incentive just to sit tight in their current home unless they absolutely have to move.
But wait a minute — wouldn’t homeowners with adjustable rate mortgages eventually be subject to today’s higher rates? They certainly would be. But for a number of reasons, such as the role of adjustable rate mortgages in the 2008 financial crisis and the very low rates that have been available for fixed-rate loans, Americans have comparatively little adjustable rate debt these days:
As a quick aside, it’s interesting to note that the long-term fixed rate mortgage, so familiar to us in the United States, is actually quite rare across the globe. In most other countries, adjustable rate or short-term fixed rate loans predominate. (This gives further weight to the idea of conventional 30-year mortgages as investors’ golden tickets: uniquely attractive loan products that supercharge your ROI without introducing much risk. This excellent article discusses mortgage products in other developed countries, if you want to dive deeper into that topic.)
But let’s get back to the main point: it’s clear that this lock-in effect will be much more pronounced in the United States than in most of our peer countries because of the primacy of long-term fixed rate debt here. Pronounced enough, in fact, that we’re now facing market conditions that can only be described as…a bit weird.
Let’s let the data tell the story:
Demand has softened significantly, in part due to higher interest rates discouraging buyers.
This has led to a sharp decrease in the number of homes sold since the beginning of 2022…
…and a moderate increase in days on market since the beginning of 2022.
(Note there is regular seasonality in this metric.)
But sellers are locked in. Starting in mid-2022, the number of newly-listed homes plunged, and homes are now coming to market at about half the normal rate:
Because of the lack of new listings, total for-sale inventory remains at or near records lows, making it difficult for even the small number of active buyers to find a house.
The effects of soft demand and restricted inventory counterbalance each other, leading to home prices that are relatively stable.
(Note: there are regular seasonal swings here as well.)
So what happens from here? Well, the lock-in effect won’t ease until mortgage rates fall, which some forecasters say is possible in 2024. If that happens, the market should begin to thaw on both sides: more buyers will be looking for (and able to afford) homes, while more sellers will be willing to list their homes for sale and trade into a new one.
But until mortgage rates fall, these unusual “locked in” market conditions are likely to persist.
Portfolio Updates
I still have one tenant in the middle of bankruptcy/eviction proceedings, without much progress yet.
I thought I was going to have a vacancy coming up at the end of August. The tenant gave their notice-to-vacate months ago, at which point I offered to lower their rent a bit if they stayed — I turned this property last year, and definitely wanted to avoid turning it two years in a row. The tenant asked for some unneeded cosmetic work to be done in order to stay, which I declined. So they indicated they would vacate as planned. But in a surprise turn, they ultimately signed the renewal anyway, perhaps realizing that my rent offer was attractive compared to what they could find in the market. (Or perhaps they just wanted to avoid the cost and hassle of a move.) Either way, they’ll be staying another year with a reduction in rent, and I avoided a turn — so it’s a win-win.
Elsewhere, July was a bit of a down month for my portfolio (as I published in my July Portfolio Report), mostly due to significant maintenance & repair expenses. I’ve added the new month to my cash flow graph, and my 2023 totals:
In Other News…
Domestic News, Business, & Real Estate
Wildfires devastate Hawaii. Fast-moving fires leveled the historic town of Lahaina and killed over 100 people (the death toll is expected to rise.) In its speed, ferocity, loss of life, and destruction of an entire town, this fire has echoes of the Camp Fire in 2018 that destroyed over 19,000 structures and consumed the town of Paradise, CA.
Nuclear reactor in Georgia goes online. The first new American nuclear reactor in decades powered up several weeks ago. Some argue that nuclear is a necessary part of a clean-energy future, but this new reactor didn’t come easy: it was expected to take 7 years and $14B to build, but instead it took 14 years and $35B. In those 14 years, the cost of wind and solar production plummeted, calling into question the viability of nuclear power on a cost basis.
The Inflation Reduction Act turns one year old. Inflation has indeed come down, but that likely has very little to do with the landmark legislation, which was primarily focused on climate and green energy investments. That part is working well: while the biggest impacts of the law don’t kick in until 2024 and 2025, it is already spurring a massive increase in green energy investment, with over $132B in new projects already announced that have created (or will create) over 80,000 jobs. Bank of America also released a detailed report on the law and its current and future impacts on energy investments.
WeWork could soon go bankrupt. The famously overhyped provider of coworking office space is teetering on the edge of bankruptcy. WeWork was never a lifestyle brand, or a technology company, or a world-changing movement, or anything else its founder Adam Neumann wanted investors to believe. It was always just an unprofitable real estate company, and it still is.
UPS (probably) averts costly strike. UPS struck a deal with its union that will include sizable raises for all employees, as well as other benefits. The deal must still be ratified by the union before going into effect.
Uber finally posts a profit. After nearly a decade of huge venture capital investment and breathless predictions, Uber finally posted a quarterly profit of $326M. Not bad, but they have a long way to go: since Uber started reporting its finances in 2014, it has racked up cumulative losses of $31B (yes, that’s billion with a “b”.)
Twitter becomes “X”. Twitter changed its name and logo to X, in the worst branding move since HBO Max became just…Max. Elon Musk has long been weirdly obsessed with the letter, which perhaps explains why he thinks torching Twitter’s most recognizable and valuable asset (the bird logo) is a great idea. More evidence of his genius! And if you’re thinking, “Hey wait a minute, aren’t there lots of other companies who have used and trademarked the letter X”, you’d be right: in fact, there are 900 of them, making it quite possible that Twitter – sorry, X – will have to fend off multiple lawsuits associated with the name change. Finally, in a perfectly Muskian coda to this story, he put up a giant flashing “X” sign on the San Francisco company headquarters, but was forced to take it down less than a week later.
International News, Science & Technology
Political crisis in Israel. Israel passed a law to limit the power of the judiciary, sparking mass protests across the country. Prime Minister Benjamin Netanyahu pushed the reforms through despite unusually vocal opposition from business, military, and political leaders.
China seems to be in economic trouble. China has been an economic juggernaut for decades, but it now faces significant challenges, including slowing growth, rising debt, low birth rate & declining population, high unemployment, and deflation.
The James Webb Telescope is (still) awesome. I watched the recently released Netflix documentary on the James Webb Space Telescope, which reminded me all over again what an astonishing accomplishment this telescope was. (I should say IS — it’s out there right now, a million miles from Earth, doing science!)
Arts & Culture, Sports, and All the Rest
It’s a Barbie world. For the first time in what seems like forever, the world’s biggest hit movie doesn’t have a Marvel superhero in it. Barbie has so far taken in over $1B in global ticket sales.
Women’s World Cup concludes. The global soccer football competition wraps up this weekend, with England taking on Spain. The two-time defending champion United States team lost on penalty kicks in their first-round knockout match.
Liam and Olivia are the most popular baby names…again. The Social Security Administration published its annual list of the most popular baby names. For the 6th straight year, Liam was the most popular boys name, and Olivia was most popular for girls for the 4th straight year. It’s noteworthy that the most popular names don’t achieve the same dominance they used to: for example, while old stalwarts like Robert, James, Michael, Mary, and Linda were chosen for nearly 3% of babies at the peak of their popularity, Liam and Olivia are both well below 1%. I guess in our age of hyper-individualism, nobody wants to be a Michael or Mary anymore. (Track your own name here, but be warned: this data is surprisingly fun and addictive.)
Final Thoughts: Work / Life
The acute phase of the Covid-19 pandemic is over, but we’re still feeling its effects in various ways. This isn’t too surprising, of course — the pandemic was a civilization-altering event, creating a level of disruption to our collective way of life that most of us had never experienced, or even imagined was possible.
So yeah…some things are different now.
One thing that has changed is how and where we work. Companies learned they could function just fine (and less expensively) with employees at home, workers learned they (mostly) liked this better, and everyone was happy. This has begun to snap back a bit — CEO’s realized that having teams at home for six months might be fine, but six years is another matter — so they began drafting their RTO (return-to-office) plans. Still, it now seems certain that the traditional 5-day week is history for many office workers, as a new normal of ~3 days a week in the office takes hold.
That’s a huge deal, when you stop and think about it. (It’s also is having long-tail effects on commercial real estate and office landlords, as I discussed in last month’s Roundup.)
But it’s not just workers’ schedules that have changed — it’s their priorities. This is clear in trends like “quiet quitting”, and in the strong pushback companies faced when they attempted to bring workers back to the office full time. There’s a growing sense that work should support your life, but not BE your life. Now that workers have had a taste of a better lifestyle, and seen what’s possible, they are refusing to give back their gains.
And companies are, at least to some extent, giving them what they want. Maybe that’s why worker satisfaction increased dramatically in 2022 compared to 2021, to the highest level ever recorded. Most of the increase came not because of compensation or benefits, but from workers’ satisfaction with the experience of work (i.e. “work-life balance”.)
But I’d argue there’s something deeper going on: the pandemic also damaged our psyches. I lived through the early days of the pandemic in New York City, which were absolutely terrifying: hospitals overwhelmed, the city shut down, everyone worried about they were going to get groceries (or if the shelves would even remain stocked). The virus itself was scary, of course, and nobody wanted to get sick. But even scarier was the realization that everything — food, shelter, work, all that we take for granted, human civilization itself — rests on such shaky ground.
The pandemic reminded us that for all our progress, civilization remains deeply, frighteningly vulnerable. It’s not guaranteed. It can all come crashing down — FAST, and with no warning.
And if that realization doesn’t ignite a certain “YOLO” mentality, nothing will. I think it was this psychological shock that has reordered people’s priorities, and convinced us that…maybe work isn’t so important after all. So we wonder…maybe we should quit. Maybe we should move to a new place. Maybe we should take that dream trip. Maybe we should start a family. Maybe we should invest in rental properties. Maybe, maybe, maybe…but we’re definitely NOT keen to work 60+ hours a week with a miserable commute. We just can’t abide that anymore, seeing what we’ve seen, knowing what we know.
And there’s an urgency to it. People realize that the time to do stuff is NOW. Post-pandemic travel is on fire, for example. If you felt like everyone you know was in Europe this summer, you’re right — I was in Europe, and I assure you, everyone was there. Even the uber-rich are not immune: they’re gobbling up wildly expensive adventure/experiential travel like never before.
More people are realizing that when it comes to “work-life balance”, life should come first. (“Life-work balance”, perhaps?) That’s a good thing, and I certainly agree. In fact, this is the big idea that undergirds most of the FIRE movement, and that motivated my own strong desire to use rental properties to escape the office grind. I wanted to live life on my own terms, and make intentional decisions about how I spend my precious, limited time. The pandemic only reinforced my commitment to this idea.
Whatever you want for your life, for your future, the time to take action is now. Among the pandemic’s many consequences, the most profound may be the tiny voice lingering in our minds that reminds us: “Tomorrow might be too late.”
Happy investing,
Eric
About the Author
Hi, I’m Eric! I used cash-flowing rental properties to leave my corporate career at age 39. I started Rental Income Advisors in 2020 to help other people achieve their own goals through real estate investing.
My blog focuses on learning & education for new investors, and I make numerous tools & resources available for free, including my industry-leading Rental Property Analyzer.
I also now serve as a coach to dozens of private clients starting their own journeys investing in rental properties, and have helped my clients buy millions of dollars (and counting) in real estate. To chat with me about coaching, schedule a free initial consultation.
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