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Comment by nemo44x | Hacker News Reader

Real estate will always be priced at what buyers in an area can afford per month when factoring in home price, mortgage interest, and taxes.

Areas of CA and UT have appreciated faster than other locations mainly due to the popularity of living there for professionals. But a big part of the real estate price boom has been declining interest rates.

When you’re looking at property that costs many hundreds of thousands and into the 1m range, even a single interest point can have a dramatic effect. Because interest rates have fallen so much, value has moved into the cost of the real estate.

If interest rates were to rise to 8% for example, you’d see the pricing of these homes cut in half. It’s what the market can afford monthly that sets the price.

Of course if interest rates were to rise like that, an all cash purchase begins to make sense.

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> Real estate will always be priced at what buyers in an area can afford per month when factoring in home price, mortgage interest, and taxes

This was the model that led me to believe there were problems in the housing market in ~2005. Well, technically, it was the concrete evidence that this model was being violated. House prices in South Florida, where I lived at the time, tripled in ~5 years, but incomes did not. Robert Shiller had a graph of housing prices normalized to income from 1890-2005 in the NYT in 2005. Price-Income generally stayed flat, with the exception of a bump after WW2, the S&L crisis in the late 80's, and an enormous launch in the early 2000's.

As I see it, current housing prices are being forced out of the traditional model by the effects of the Fed's QE efforts.

> As I see it, current housing prices are being forced out of the traditional model by the effects of the Fed's QE efforts.

Very likely true. The financial crisis messed everything up. Driving interest rates down and QE stemmed the bleeding but it is only prolonging the pain. Possibly we are in a new normal of low-to-negative interest rates for the extended future. If this is the case, expect homes to continue to rise in value and for people with access to cheap capital to continue to pull away from everyone else.

I'm not optimistic interest rates will rise as inflation stays low. They tried raising rates last year and it shook the markets and there just doesn't seem to be a stomach for a prolonged reckoning.

> I'm not optimistic interest rates will rise as inflation stays low.

I agree that interest rates are likely to stay low.

I find it ironic to think of as inflation as low, given that housing is way out of its historical pricing band relative to the model factors.

Money is cheap. Homes in particular rely a lot on financing. Goods that don’t rely on financing are relatively cheap since inflation has been so low. I believe in part because money is so cheap currently that businesses are able to sell bonds cheaply to finance their operation. Because of this the savings are passed down to consumers.

But house prices have more to do with interest rates than inflation currently I suspect.

I think it's because most people don't decide how much house they can afford based on the purchase price. They decide based on the monthly payment. Obviously, as the interest rate declines, they can buy more for the same monthly payment. Therefore house prices go up, because everyone can pay more for the same monthly payment.

I remember when interest rates fell from 9% to 7% (early 90s). We had just bought a house for about $60K. Then interest rates fell, and house prices jumped, and suddenly our house was worth 90K. But if we had bought the same house at 90K at 7%, our monthly payments would have been the same.

I agree that monthly payment is the key factor people consider. I think there's more to it than interest rates, though, let me demonstrate:

I took a generic mortgage calculator and ran the numbers (30 year mortgage) on your house (first two rows), and on a South Florida townhouse that used to be mine (second two rows), to illustrate:

Price Rate Monthly Lifetime

60000 9 483 173798

90000 7 599 215558

142000 7 945 340000

309000 3 1303 468992

Note that the monthly payments are 24-37% higher in their after scenarios, even with a low, low interest rate for my townhouse. I see this scenario playing out over and over again and people assign the difference to interest rates when crunching the numbers suggests there's more to it.

Even if you didn't purchase all cash, with a lower house price you can more easily pay off the house early by paying extra each month. The way it works now keeps people paying monthly way longer.

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