Experts Say Investment Activity Likely To Fall, May Take Real Estate Market With It

The demand for homes as investments may soon diminish, dragging down inflated house prices and choking consumer spending, housing analysts and industry executives say. Torrid demand for investment properties helped fuel the past five years of record home sales and propped the economy considerable, but that could soon be a distant memory as the fate of the real estate bubble comes into focus.

An unusual spike in short-term interest rates will thwart many second home buyers who have been counting on low adjustable-rate mortgages for savings and/or affordability. Whether for vacation, retirement, cash flow or a quick flip, the incentive to invest in homes is shriveling, experts say.

“The stats that we’ve all seen show anywhere from 15 to 25 percent of all home purchases right now are from investors and second homeowners,” said Robert Foregger, chief strategy officer at EverBank in Stowe, Vermont. “If you revert to the mean, you could have between maybe 10 and 20 percent of the market that could really just dry up. If it does, it has the potential to put more downward pressure on prices.”

This decade’s record sales and appreciation rates are seen as unsustainable.

Economists look for slowing this year, but from historical standpoints, still robust numbers. A widespread investor pullout is considered a major risk. Nearly 33 percent of new home loans last year were adjustable-rate mortgages, which carry a low initial rate that later gets reset. These loans, and more exotic mortgages, made buying homes appealing as prices soared and the stock market seemed less of a sure bet.

But an inflation-fighting campaign by the Federal Reserve sent short-term rates up sharply in the past year and a half. Last week, for the first time in five years, two-year Treasury yields surpassed the yield on 10-year notes. The rate advantage of ARMs disappeared, leaving homeowners in a rush to refinance and lock in low rates on fixed-rate loans. The pain will be felt by the new buyer, people already facing affordability problems, and the investor.

The share of ARMs used this year reached the highest levels since Freddie Mac began tracking them a decade ago. One of the most popular products is a 5/1 hybrid ARM that has a fixed rate for five years and then resets annually. With mortgage rates expected to rise, these loans make sense for homeowners who sell by then, but could otherwise be painful. If the yield curve inverts more deeply and home price gains slow or reverse, ripple effects could be severe.

“I think people who were trying to get into investment properties and trying to flip them won’t see those financial advantages with the short-term rates being higher than the long-term rates,” said Bob Moulton, president of Americana Mortgage Group in Manhasset, N.Y., located in Nassau County, Long Island.

Home sales in recent months are already more modest than the figures that drove home prices up 53 percent nationwide in the last five years, according to government data. Markets such as Arizona real estate and California real estate have soared nearly 110 percent this decade, encouraging even greater demand for ARMs and exotic loans with low initial rates.

“Buyers to be concerned about are those who couldn’t afford a fixed-rate mortgage when rates were below 6 percent and opted for an interest-only or other adjustable-rate mortgage as a way to keep payments low. Many buyers won’t be able to get the deal done like they could when short-term adjustable rates were much lower,” said Greg McBride, senior financial analyst at Bankrate, Inc. in North Palm Beach, Florida.

The extent of the slide will vary, but home prices are still more apt to fall regionally than nationally, McBride said. So how bleak is the current picture? The one advantage to being a prospective Florida home loan investor, over most parts of the country, is the state’s perpetual appeal to out-of-state transplants and second-home buyers. Therefore, the local markets may see less turbulence in the upcoming months and years than most of the country.