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Boots on the Ground - September 2023

The gloves are off for homebuyers...and for good reason! The month of August saw some of the highest mortgage rates since the year 2000, topping off (for now) at an average around 7.5% before cooling again with a slow decline back towards 7%. By all accounts, September won't offer much in the way of relief and a bounce back up to 7.5% or higher is likely to happen.

This hasn't necessarily slowed buyers down (at least the ones who are active) but it's certainly changing how offers are being written. So far this year I've both written, and received, some of the most aggressively "low" offers I've seen in my time in real estate.

For the most part, I view these as an opening move to kick off negotiations until the right buttons are pressed to help solve for the main problem affecting homebuyers right now - affordability.

Interestingly, there's one area where homebuyers don't seem to be having any affordability issues. New Homes.

Sales on new homes have been skyrocketing, so much so, that famed investor Warren Buffet has added major positions to his investment fund with new home builders like Lennar and D.R. Horton. But, why is he so confident that these companies can navigate the rough waters ahead so much better than the rest of the market?

The answer to that, I think, is twofold. First and foremost, new homes are the only thing feeding supply into this starving market - but perhaps more importantly - new home builders have been able to solve for affordability by offering and advertising mortgage rates much lower than "market rates".

How? Easy, they simply find what the maximum mortgage rate "buy-down" costs and build that into the price of their homes.

To understand how this works you first need to understand what a rate buy-down is. Essentially, a borrower can pay 1% of the loan amount up front (as part of the closing costs) to buy one "point" off the mortgage. This usually translates to about 0.25% of the interest rate. The cost for each point will typically increase the more you buy until buying additional points off the mortgage will get unreasonably expensive.

For some borrowers, 4 points could mean you get a rate that's about 1% or more below market rates. I'm working with a buyer right now that was able to negotiate for a seller to pay for their buy-down from 6.65% to 5.375% - so their rate is about 1.275% lower. The cost of that buy-down? $50,000...

Understandably, there is a visceral gut reaction that both buyers and sellers will have to these kinds of numbers. That reaction almost always plays out like this:

Seller: "$50,000?? I'm not doing that!!" "Let's find a better buyer, we just need a cash buyer from California! Tell them to go to hell!" (or some variation of this).

Buyer: "Why would I do that!! For 1.125%???? No, I want them to reduce their price!! I'll just refi when rates come down next year!"

And the reactions you see above are exactly why Warren Buffet has decided to invest almost $1 billion in new home builders. Because he knows that homebuilders will continue to win in the current market simply due to the fact that they ARE willing to buy these mortgage rates down (and understand the value in doing so) plus they have the tools to trick homebuyers into thinking that they simply have some special agreement with lenders that gets them a super low mortgage rate.

He also understands that rates aren't likely to "come down" in the near future and will probably only see low points around the 5.5% range for the next decade or more. Beyond that, the likelihood is very low that all parties to a real estate transaction will be financially savvy enough to understand how a monster rate buy down is the most winning solution in today's market.

Sticking with the example of my current buyer - the rate buy-down will save them about $975 per month on their mortgage. Okay great?! So it costs $50,000 to save a measly $975 per month?? So maybe they come out on top if rates don't go down for 5 years...big whoop...

Not so fast. That's just one small piece to this equation. By changing their mortgage rate they're also lowering the amount they'll be paying in interest AND increasing the amount they're contributing to principal. To find this you need a working amortization schedule, which I've built in excel so I can show buyers the mechanics behind it all.

For these folks, they'll save about $15,000 in interest for the first year and about $5,000 more in principal. In total, they'll benefit by almost $32,000 in their first year - and that number will grow in year two, and again in year three...and so on.

By year 5 they''ll be ahead by well over $200,000 once you combine interest savings, savings on payment and additional principal paid. For anyone outside of house-flippers, these kinds of savings provide much more value than a discount on price.

Sadly, Warren Buffet is probably right to bet against the existing home market catching onto this formula by and large. As I've found time and again, there's almost always one party to the transaction that just doesn't get it and there are a lot parties to each transaction.

The people winning in today's market, on both sides, are the ones who understand that each transaction is as much (if not more) about "mortgage-buying" as it is about "home-buying".

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