John M. Lee: Effect of War on Real Estate

With the start of the war on Iraq March 19, many questions have come up on how it will affect the real estate market.

As everyone is aware, the real estate market has been the only bright spot in this economy. With massive layoffs and a crashing stock market, real estate has held up surprisingly well because interest rates kept decreasing.

When interest rates drop, housing costs decrease, allowing buyers to purchase more. As well, homeowners can refinance, lowering their monthly payments, or they can take out a larger loan, resulting in more disposable income in their pockets.

Even though business spending has been down, consumer spending has kept pace with previous years, thus helping our economy stay where it is today. The biggest worry to our real estate market was the uncertainty caused by the possibility of a war with Iraq and increasing interest rates. Well, both are here now - let's examine how these will affect the real estate market in the future.

With war comes the issue of financing the war. Recent estimates are $100 billion for a short war and much more if it is a long war. The government will borrow money to finance the war. Since interest rates are tied to the demand for money, and the government needs more money, the interest rate has to increase.

In late March we saw mortgage rates go up about a half percentage point. Also, we typically get a relief rally on Wall Street when the war breaks out. Remember that investors hate uncertainty and invest their money in safer instruments, such as bonds, during times of uncertainty. With the outbreak of war, there are some feelings of certainty that it will be over soon. Investors begin to move money from the bond market into the stock market, causing the stock market to go up, as it did in late March.

When stocks go up, bonds go down and yields, or interest rates, go up. This is what we saw in the stock and bond markets at the end of March. It was not surprising to see mortgage rates go up a half a percentage point. How has this affected the real estate market?

Theoretically, when the interest rates go up, the real estate market slows down because buyers can now only afford a lower mortgage, leading to lower real estate prices. Also, during the last war with Iraq in the early '90s, the real estate market came to a halt.

During a crisis, buyers tend to focus their attention more on the crisis and ignore housing needs for a while. For example, after the Sept. 11 incident in 2001, the real estate market stopped dead in its tracks in the fourth quarter of that year. Currently, however, I have not seen any signs of a real estate slowdown. Sales activity seems to be fairly brisk.

There are several reasons for this calm and "business as usual." With interest rates inching up, some people are betting this will be the lowest interest rates we will see for the next 30 - 40 years. If they are going to remain in their homes for the long term, it's better to lock in now on a low rate they can keep for as long as they own the home.

Buying later, they will have a higher interest rate and higher payments.

Also, this war is being fought on foreign soil, unlike the damage that occurred in New York City. After Sept. 11, people were glued to the television, watching images of the Twin Towers collapsing over and over again, and feeling the grief that gripped this nation.

This time around, though, the sentiment seems to be that war is bad but the outcome is certain - it is a matter of time and then we will claim victory, resulting in a more positive feeling. Thus the real estate market has not been affected much yet.

At the moment, we have not seen any panic by buyers and sellers. Usually with a nudge in interest rates, buyers are scrambling to purchase a property before rates go up. Only time will tell whether this market will last and do well.

Our hope is that this war is short lived, with a small number of casualties on both sides, so we can go on with our lives in a better world.

John M. Lee is a top-selling real estate broker at Pacific Union. If you have any questions regarding real estate, call him at (415) 447-6231 or e-mail him at johnlee@isellsf.com.