Mortgage Rates Report

No recommendation until tomorrow.  All eyes are on the Federal Reserve Open Market Committee today.  At 2:15PM (EDT), 11:15 (PDT), they will release their interest rate decision and statement.  The fixed income securities market believe there is a 43% chance that the Fed will RAISE rates, to stifle inflation, in August and that there is a 61% chance that the hike will come in November.

The eyes will be on the Fed's commentary, though:

"We expect the Fed to keep the funds rate at 2% today but to shift to a more hawkish statement by placing more emphasis on inflation over growth risks," strategists at Credit Suisse wrote in a research report. "The Fed will likely use this meeting as an opportunity to set the stage for a potential rate rise in August."

If the Fed signals that rates could rise as early as August, expect mortgage rates to jump .25% higher, from today's 6.375% 30 year fixed rate, over the next few weeks.  If the Fed signals rate hikes are "possible" as a way to fight inflation, expect rates to stay level through in July (6.25% to 6.5%).  Finally, if the Fed shifts back to its anti-recessinary talk, we could see rates drop down to 6%.

As you can see, there are a lot of "ifs".  This is why today's Fed commentary is all important.  The Fed's ambiguity has traders convinced that higher rates are a foregone conclusion.  Here's the silver lining hidden in this dark cloud; mortgage rates are equal to what they were in July, 2007.  The Fed Funds rate was at 5.25%, then.  Today, the Fed funds rate is at 2.25%.  What that means is that mortgage rates SHOULD be able to withstand some 5-6 rate hikes and stay under 7%.

Alas, markets are discounting mechanisms.  We still think there is a lot of risk to higher mortgage rates until the commodities bubble bursts.

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Have you considered the 92057 zip code in Oceanside for your next investment property?  We think there is a compelling argument for the long-term property investor.  Consider this question on Trulia Voices:

I said:

Do a home search for properties in the 92057 Zip code, on Trulia- keep it to under $225,000.  Most of these properties sold north of $400K, in 2005. While that was overblown, you can see that there is a lot of room there for growth over a 5-10 year period.  They were once valued that high, now they're about half of the 2005 values.   Now, click this link- Marine Corps NCOs receive about $1,500-$1700/month for housing (and they spend it).

$20% down on a $200,000 home will have a PITI of about $1,550.

That's positive cash flow, ladies and gentlemen.  The challenge for this investor will be that most of the homes were built in the 1970's so he can't get a newer home.  He will be able to avoid the Mello-Roos tax so that will make his cash-flow all the more juicy.

Will the property rise to its 2005 values?  It may take ten years, like the recovery from the last distression, or longer.  However, a down payment and closing costs would be about $45,000 to own this home.  The rents will cover the payments and a depreciation tax break wil be available to the owner. 

How will the investor receive a 10% return, over a ten-year period?  The Rule of 72 says that if the $45,000 doubles, to $90,000, in 7 years, the return will be a skosh over 10%.  This means that a sales price of $275,000, by 2015, will get the investor a 10% return.  Admittedly, 5.2% appreciation is a healthy return but we think an investor is buying the property right, at these prices.

Positive cash-flow mitigates a helluva lot of risk.

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Scripps Ranch REALTOR Kris Berg gives us the single best explanation of Mello-Roos fees I've seen:

In 1982, the Community Facilities District Act was approved by the State Legislature. The bills coauthors were Senator Henry Mello and Assemblyman Mike Roos -- Get it? The impetus for the bill was our famous Proposition 13 which was enacted in 1979 and severly limited the amount of property tax revenues which our local governments had previously enjoyed. With tax revenues limited, revenues which could be earmarked for public improvement projects and new infrastructure, a new source of funds was needed.

Spend five minutes reading Kris' conversational tutorial, at San Diego Home Blog,  and you'll never wonder what Mello-Roos fees are again.

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I know, I know... I'm shooting myself in the foot.  I'll start this essay with the conclusion; if you think prices are going to drop even farther, don't buy a home in San Diego...unless...

Let me explain.  Dean Calbraith wrote an article, in the Union Trib, about mortgage rates' affect on the affordability index in San Diego.  It was the standard industry hype from some local economists and mortgage professionals:

"The day of low interest rates is over," said Dan Seiver, an economist at San Diego State University. "Because of inflation, we'll be having interest-rate rises across the board. But having rising mortgage rates in the current real estate environment is like pouring water on a drowning man."

Eh...maybe, Dan.  You'd be surprised at the resilency of a real estate market to higher rates.  Higher inflation could also lead to higher wages, which throws the affordabilty index out the window.  Purchase prices are permanent while loans are temporary; they can always be refinanced to a lower rate during the next economic cycle.

Oh, yeah.  I almost forgot.  I've been yelling about the affordability index since last Thanksgiving and higher rates since May 2, 2008.  Panic, if you're buying a home in July- lock your rate at application.  Don't fret too much about an economic cycle, though.

Gary London, who heads The London Group Realty Advisors in San Diego, said, "It's inevitable that interest rates will rise, which will only slow what's increasingly becoming a festering situation with real estate."

Many local real estate experts say prices will decline at least through the end of this year and probably through much of 2009. The main reason for that drop is that we're only halfway through the wave of foreclosures emanating from the bursting of the housing bubble.

Maybe, Gary.  If prices plummet more than they have, as you predict, a 4% 30 year fixed rate won't get people off the fence.

Would-be home buyers face a challenge: Do you wait to buy your home until the market hits absolute rock bottom by which time interest rates may be zooming skyward? Or do you buy a home now at interest rates that are relatively cheap, and then watch the selling price of your home erode over the next year or year and a half?

That really is impossible to say.  Timing the bottom is never a good strategy for a long-term investor.  Buying a property you can afford is.  In some areas of San Diego County, prices are at their 2002 levels; a bargain indeed.  In some of the worst affected areas, prices may ALREADY have bottomed as investors step up and buy.

"The rising rates make things a lot more complicated," said T.J. Knowles, a mortgage broker with CalBrokers in Del Mar. "If you wait too long for the price to drop before buying a house while the interest rate is rising, over the long term you could cost yourself a ton of money."

Or not, TJ.    Again, prices are permanent, mortgage loans are temporary.

Call me to run the numbers.  You may very well buy a home for $400,000 today  that drops in price to $368,000, in 2009.  It may also rise to $410,000 at the end of next year.  They key component is your expected hold time.  If it's 7-10 years, you're probably going to make money, regardless of how close you come to the bottom.

Oh, now back to my conclusion:  Don't buy a home today if you think prices are going to continue to drop...unless...

they've dropped as far as they will already.

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Oceanside real estate investors have a long love affair with the Marine Corps.  Camp Pendleton (home to the First Marine Division) supplies a steady stream of young families with a need for off-base housing.  With the average housing allowance of about $1,700 (for an E-5 with a family) and dropping home prices, great opportunities are available for investors.

I'm bullish, long-term, on coastal California real estate- that's no secret.  The underlying demographics are still positive for California; more people will be moving in than moving out, over the next 20 years.  Aging baby boomers yearn for warm climes in retirement.  While California has its share of problems, it is still the "promised land" for many Americans.  The presence of the Marine Corps, in Oceanside, just makes the job of a landlord more palatable during this decline.

One investor purchased a townhome for $180,000, near the Vandergrift gate,  last month from the REO department of a mortgage lender.  This property sold for over $380,000 in 2005.  With 20% down, a mortgage of $144,000 has a PITI (including HOA) of about $1450.  Market rents are about $1500 and well within the reach of a Camp Pendleton Staff Sergeant.  The property needed some $8,000- $10,000 in repairs but we think the $50,000 required to own and renovate the property.  We think that property can be worth $275,000, in a five year period, and effectively return 15% on the original investment.

Have we reached bottom in the San Diego County housing decline?  It's too early to tell but cash-flow positive real estate investments, like we're seeing in Oceanside, certainly take the guesswork of that answer.

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