Interest cost and real value
While I am talking about property, I'll throw out another thought. It's conventional wisdom that home-buyers are most sensitive to their monthly payment, and declines in interest rates drive up selling prices in a near-perfect inverse relationship, as lower interest cost is swapped for higher sticker price, leaving the buyer with the same total cost. Call me contrarian, but I think that buying a house at times of historically low interest rates is madness. Why? Because you're fully leveraged. Let's assume that there is a nominal value to a house, and an actual value. The nominal value is the sticker price -- say, $400K for that two-bedroom apartment in Berkeley. Since the vast majority of buyers are on 15- or 30-year mortgages or their functional equivalent, a significant interest cost drives the actual value of the place -- the contracted financial commitment which the buyer undertakes in order to acquire title -- up to something like $700K. In times of low interest rates, this $700K (which is based, conventional wisdom tells us, on the buyer's ability to make 30 years x 12 months x a given monthly payment) might be made up of a nominal/sticker cost of $550K, and an implied interest cost of only $150K. In times of *high* interest rates, that $700K number might be made up of a nominal cost of only $320K, and the same overall total due to a vastly increased interest cost of $380K.
If I buy at a time of high interest rates and low sticker costs, it seems to me that I have nothing but capital gains upside from interest rates, which historically have varied cyclically (and which are due for a massive rise, if our trade deficits and the plummeting value of the dollar are any indication -- but that's another story as well). In addition to my capital gains upside (the nominal--> real value of my place going from $320K to $550K) I have the potential to refinance, getting a low low interest rate on a new mortgage to go with my low nominal cost, giving me a genuine total-cost bargain.
But what if I bought in times of low rates? The nominal value of my property can only fall on a cyclical basis, even if overall rising prices mask this somewhat; and if I've taken a variable-rate mortgage, my interest cost can only go up. In the best case, if I am forced to sell my house for any reason during a high-interest period, I'll lose out on its declined nominal value and avoid (through a fixed rate mortgage) any increase in interest costs. In the worst case, I am faced with a rising monthly payment on an asset whose value is declining precipitously, in an economy which is tanking because interest rates kill business investment. Ouch.
Have I mentioned that I'm feeling very secure being in cash?