Monday, June 06, 2005 - Fixed-Rate Mortgages Drop Again - Fixed-Rate Mortgages Drop Again


Those forecasting a real estate BUBBLE POP are scratching their heads and eating baloney this morning. I can't site a source or the numbers but I get no disagreement in my assertion that the number of baby boomers who have not purchased a second home far exceeds the number who have.

This weekend I learned that a friend is building a log cabin and a pond on 2.5 acres on a North Carolina Trout stream; it will not be available for rent. I learned that another friend is building a 2,400 square foot second home on the New River; it will not be available for rent. Not long ago a third friend bought a second home through cash out refinancing against his first home; his monthly interest and principle payment went down! He will not rent his second home.

The argument can be made that the vacation rental market is weakened each time a second home is built. However, the trend also demonstrates that retired and semi-retired folks have time to travel. The next 20 years will see the most people ever. Even more interesting is that the average retirement income will go up each year for the next 20 years! Those calling for a BUBBLE POP seem to ignore the demand side of the equation.


Low interest rates are about to set off a new refinancing boom. More than 30% of the homes in America are owned free and clear. Some of the folks who are building second homes are paying cash by financing or refinancing their first home. According to the linked WSJ article, 30 year mortgages stood at 6.51% a year ago and are now pushing 5.5%. Trillions of dollars are once again readily available to American homeowners.

The WSJ article states that David Lereah, chief economist of the National Association of Realtors has revised his sales forecast. It is now likely that home sales in 2005 will exceed the record of 6.78 million that was set last year!

The ownership of second homes is subsidized by federal tax laws. Homes that are not depreciated enjoy the benefit of interest and property tax deductions and additional benefits when the homes are sold. Sellers might sale at very low long-term capital gains rates, however some will sell their first home first--income tax free--and then convert the second home into a first home during their retirement years. Current laws allow individuals to sell their primary residence every two years and owe no tax.

There are 76 million boomers in the USA. They are between the ages of 46 and 59. The argument has been made that spending will decline when these folks actually retire. I disagree. Those who buy or build a second home spend more in many ways than those who do not. But, if it turns out to be true, it will not happen on average for another many years.


Another phenomenon that has scared talking heads is the degree of speculation. The reason there is so much speculation is because the demand for second homes is very high and the profits available are very high. Ironically those who are selling too cheap are the ones who have fueled speculation. Those who owned second homes for many years have been far too quick to jump on too small of a profit. For example, ocean front condos in the South Hampton Building traded down for 3 years after September 2001. Similar units sold in the $440,000 range in 1998 and in 2004. The price for ocean front property did something very unusual when it stayed at the same level for 6 years. The past year or two have been largely "catch-up" after the recession and extraordinary resort market after 911.

Land costs and construction costs are substantially higher now than in 1998. When the market took off, new condos similar to South Hampton units initially sold for $650,000 or more--preconstruction. By the time the buildings were complete, the new units resold for $800,000 and some have now sold for $1.2 million or more. These are up-scale resort properties in prime locations.

Real estate agents and "pin-hookers" called the owners of older units and many jumped on the chance to sale for $510-$540. After all, $540,000 was $100,000 more than the previous sale. Last week, unit 1210 was listed for sale at $889,000. The incredible thing is that relative to the new units at $1.2 million, this condo is a bargain at $889,000. The price is double the price of 1998.

The problem with ocean front property is that the rents initially pay only a small portion of all the costs of ownership. Over time, ocean front rents go up steadily and cover more and more of the principle and interest. By the time the rents are throwing off positive cash flow, the property might have doubled in value. The problem is that one must have the resources to carry the property until the rents increase.

Saturday, I participated in a discussion about real estate with several brokers, builders and investors. I was surprised to learn that many local owners of modest homes have purchased another local second home. This may actually be the smart way to play the real estate boom. After all, local housing is no where near the price of resort housing. The buyers are able to take advantage of the interest and tax deductions without paying the high prices in resort areas.

Yes, this does sound like part of a real estate bubble. However, one must remember that much money was made during the first many years of the internet "craze". The situation did not become a "" bubble until prices went totally out of reason. The local homes being purchase are only up in price 6% last year and at a compounded rate of less than 5% over the past 10 years. Adding the gain on the "interest arbitrage" and most of these second home owners are doing better than they have done in the stock market.

The "hot" areas of the country are distorting the overall numbers. Those who are not deducting interest and taxes on a second home have come to realize they are subsidizing the purchase of their neighbors second home.


Money is available and the after tax price is cheap.

Americans are buying second homes and many do not rent them.

Americans have more disposable income than ever before.

Tax laws subsidize the purchase of second homes.

When equity in first homes is used for second homes, the refinanced monthly payment may not increase.

More US citizens than ever own a home and the most ever own a second home but the percentage that own two homes is still very small.

Resort areas are hot!

Low long rates are positive for STOCKS AND REAL ESATATE!