“Steve, house prices are just too high…”
“Relative to what?” I reply.
“Huh?” they answer…
I end up having this conversation with someone almost every other day. I guess friends, family, and business colleagues just expect me to agree with them…
It’s like they’re saying, “Nice day, eh?” But I don’t reply with, “Yes, it is…” Instead I say, “Relative to what?” It’s not what they were expecting.
Here’s the thing…
Investing is all relative…
You and I make choices with our money every day, based on relative value. And that’s true even if you don’t think about it at the time.
First, think about how this works. Every time we buy something, we weigh it against something else…
Do you buy a car from General Motors, or a Toyota? Do you buy the store brand in the grocery aisle and save a few bucks, or do you buy the name brand that you know is good?
Similarly, you might ask, “Can I afford a $500,000 mortgage right now?”
How would you decide? You’d probably ask yourself, “What’s my monthly mortgage payment right now relative to my income?”
You make every financial decision relative to something else. If you didn’t, you’d have no way to know if prices are “too high.”
Housing is the perfect example of this today…
Let’s say you’re looking at that $500,000 house. You’re worried, because the price of this particular house is the highest it has ever been. You really like the house. But you are afraid “asset prices are just too high.”
Should you buy it? To decide, we should look at one critical factor here – interest rates.
Today, almost unbelievably, 30-year mortgage rates are at record lows – near 3% interest. So your monthly payment on a $500,000 mortgage at 3% interest is just $2,100 (not including property taxes and insurance).
But what if mortgage rates were at record highs today, not record lows?
In October 1981, mortgage rates hit record highs – nearly 19%. At a 19% rate, you’d pay nearly $8,000 a month on your $500,000 loan.
$8,000 versus $2,000 – what a difference!
So… is that $500,000 house worth buying right now?
Is that asset priced too high… or not?
When interest rates are 19%, that house is probably priced too high. Your mortgage would cost you $8,000 a month.
But when interest rates are at record lows (like they are now), you can probably afford that house… Its monthly payment is only $2,100.
The price of the asset – the house – is unchanged. It’s the relative value of that asset that has completely changed – its value relative to interest rates.
The difference is incredible. And we can see this same idea at work in one of the housing market’s main drivers… affordability.
Housing affordability is simply the “cost” of a home relative to your income. It’s not the price of the home that matters – it’s the monthly payment.
The payment part is key. Because as we just covered, that includes interest rates. And low interest rates make investments like houses more affordable.
By looking at incomes, home prices, and interest rates, the National Association of Realtors calculates a housing affordability figure. This measure hit 167 in the latest report. That means someone with the typical income can afford 167% of the typical home price in America.
That’s last quarter’s data, though… Interest rates have fallen more since then. And that means affordability is on the rise. Based on today’s low rates, housing affordability is now as high as we’ve ever seen, outside of the housing bust lows.
You wouldn’t know it by simply looking at home prices. But by examining relative value, the reality becomes clear.
This is an incredible tailwind for the housing market. Interest rates are down dramatically, and that makes housing cheap… even though prices haven’t fallen.
It’s why I continue to be bullish on housing in the U.S. Tomorrow, I’ll share one simple way you can take advantage of it.
Good investing,
— Steve
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Source: Daily Wealth