Will Brexit Create A US Real Estate Dividend?

The June 23rd decision by the Brits to leave the European Union has driven US mortgage rates into the ground, but can such results continue? So far, just …

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The June 23rd decision by the Brits to leave the European Union has driven US mortgage rates into the ground, but can such results continue?

So far, just a few weeks after the vote, mortgage rates have sunk about 15 basis points. Interest levels for 30-year, fixed-rate, prime mortgages went from 3.56 percent for the week of June 23rd to 3.41 percent for the week of July 7th.

“At 3.41 percent,” said Freddie Mac, “the 30-year fixed-rate mortgage is just 10 basis points from its November 2012 all-time record low of 3.31 percent.”

The big question is what will happen from this point forward. Has the Brexit vote created a temporary shock or does something more substantial loom ahead? For example, can we expect low mortgage rates for the next several years?

No one, of course, has a crystal ball, but there’s a very good case to be made for continuing low mortgage rates, a case which closely involves the Brexit vote.

The European Union

The idea of the European Union was to create a huge inter-connected market, one that could compete with the efficiencies and economies of the US. And, to a great degree, the project has been successful: the EU today includes 28 member nations as well as 510 million people. Not only that, the European Union has a gross national product of $18.5 trillion – more than the US.

The catch is that the EU has always had divisions. There are huge differences among the member nations in terms of languages, history and traditions, including big distinctions between the UK and it’s cousins on the Continent. For example, Britain, an island nation, is part of the EU for purposes of trade and travel and yet it continues to use the pound rather than the Euro.

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The EU is an economic experiment, one which is in great trouble. The EU unemployment rate is generally 8.6 percent but that rate is not distributed equally. Greece is at 24.1 percent, Spain is at 19.8 percent, Germany is at 4.2 percent and Britain is at 5 percent.

The European Central Bank – the equivalent of our Federal Reserve – set its benchmark interest rate at -.40 percent in March, continuing a string of negative rates which began in 2014. Worldwide, more than $10 trillion is invested with negative rates.

US Mortgage Rates

Many observers predicted that US mortgage costs would rise this year, especially after the Fed increased the federal funds target rate to .50 percent in December. In fact, mortgage rates have fallen steadily, going from 3.97 percent before the Fed announcement to 3.41 percent in early July.

While the Fed has repeatedly indicated that it would like to see higher bank rates, mortgages are increasingly originated by nonbanks which have the ability to acquire funds from overseas – places where negative interest is entirely common. In effect, we now have a two-track lending system, traditional lenders controlled by the Fed and a parallel system of new players who can get money worldwide with electronic speed and who are rapidly gaining market share in the mortgage arena.

The Brexit Impact

The British decision to leave the EU has created instant turmoil and uncertainty in world markets, an upheaval which has settled down for the time being, but is likely far from over. The reason is that the terms of a British exit are so unclear it’s entirely possible that Britain will never leave the EU.

The international law firm of Seyfarth Shaw has an excellent explanation of the exit process, a process which is gloriously complex and uncertain, an arrangement which means entanglements and arguments for years to come.

In basic terms, the British must give the EU an “Article 50” notice. After the notice is given the Brits will have to work out the exit details with the EU, a process which might take as long as a decade.

Next comes the fun part.

“Once negotiations are concluded,” says the Seyfarth Shaw report, “the withdrawal agreement will need to be ratified by the UK and the EU and, in the latter case, this means ratification by all 27 remaining member states which is unlikely to happen quickly.”

Meanwhile, as all of this back and forth is going on, the European Union, an immense market and a major US trading partner, will be in turmoil. Investors with capital will be looking for safe havens, places where their money can do better than earn negative interest. We can expect that funds will continue to flow into the US and more money (supply) suggests lower mortgage rates within our borders for a very long time. In fact, you can already see the first evidence of a Brexit mortgage dividend.

“Volatility in international financial markets often triggers a ‘flight to safety,’ with investors targeting U.S. real estate, and especially U.S. Treasuries,” explained Rick Sharga, executive vice president at Ten-X.com, an online real estate marketplace. “This influx of capital drives yields on these bonds down, and since mortgage rates tend to directly follow Treasury bond yields, it’s very possible we’ll set an all-time low on the 30-year mortgage before all is said and done.”

“In light of this recent activity,” said Freddie Mac in its July Outlook forecast, “we have lowered our 10-year Treasury rate forecast by 40 basis points to 1.8 percent and 2.3 percent in 2016 and 2017 respectively. Accordingly, we have also lowered our 30-year fixed-rate mortgage forecast for both 2016 (by 30 basis points) and 2017 (by 50 basis points) to 3.6 percent and 4.0 percent, respectively.”

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