Sticky prices in application

Consider a buyer who is interested in acquiring a particular home. A year earlier, the buyer qualified to borrow sufficient funds to pay the seller’s then asking price.

However, in the intervening year, mortgage rates jumped, and the buyer is now unable to borrow the same amount of money.

Unsurprisingly, the property the buyer was able to buy just a few months ago is now priced out of reach due to the interest rate change, not an increase in the price. The buyer now only qualifies to purchase the property at a lower price.

However, as is usually the case, the buyer is not interested in purchasing a lesser quality of property than the one they once were previously qualified to buy. Buyers, psychologically, will rarely downgrade. They will instead wait until prices or interest rates drop, or their income significantly increases.

Interest rates will continue to rise during the next couple of decades. In turn, seller’s prices will need to correspondingly drop, when they are asking more than the equivalent rise in annual consumer inflation.

The agent’s initial solution to keep their sales volume from dropping is to negotiate a change in the seller’s price to accommodate the realities of the mortgage rate change. If not, buyers and sellers will stand still with little to no ability to make a deal.

The buyer’s income when making an offer to buy is static, like the position of a fulcrum about which other dynamics move events. Most sales involve a mortgage lender, but the maximum amount of principal they lend to fund a purchase is static, dictated as no more than 31% of the buyer’s gross income for mortgage payments. Further, the lender’s mortgage rate at the moment the buyer is approved for a mortgage is also static, set by the bond market which dictates mortgage rates and no one else.

So, who needs to give? Buyers can’t, lenders won’t. So, sellers alone need to adjust by asking the “going price” for their property — when their intention is to sell, not simply test the market at the expense of the listing agent’s efforts.

When the seller does not adjust their price expectations, they exit the market — but only after the seller’s agent spends protracted time and effort marketing the property. Thus, seller’s agents will fast learn to “fire” their sellers who are not ready to sell at today’s prices.

Source: First Tuesday Journal Editorial Staffs