One of the leading home builders says mortgage rates will begin to rise in the next few weeks as the Federal Reserve's quantitative easing program, or QE2, winds down. And Bob Toll would not be surprised to see rates spike from 4½% now up to 7½% within two years. But the founder of Toll Bros. also says even with home prices down 30% to 50%, and rates at "beyond-belief" levels, housing remains a buyer's market. I spoke with Toll about why his industry has been missing in action in the economic recovery and whether that signals tougher economic times ahead. The following is our talk, edited for clarity and length. Q: Can you characterize where we are in this recovery?
A: We're slowly getting better. There's no reason to celebrate if you're a seller. It's a buyer's market, but that's got some opposing facts that make it a good time, such as interest rates that are beyond belief and prices that are, in some cases, down 30%, unless we're talking distressed, in which case prices can be down 40% or 50%.
Q: Why has housing taken so long to recover, and how much supply is on the market?
A: Supply in the market really has to be divided to understand where we are. You have a distressed market, which is short sales and foreclosures. Then you have an existing home market that is not a short sale or a foreclosure. Then you have a new home market. So you have three distinct markets. You've got still a load of supply of foreclosure, though it's less than it was. You do not have new home supply at all. New home sales have gone down to 250,000 a year single-family, 300,000 a year on an annualized basis. That's less than a third of a normal year supply for new home sales.
Q: Are prices still coming down?
A: In some places you see price increases in new homes. At the same time, you see price decreases on short sales and on foreclosures. And that makes sense because some of that has been around for a long enough time for the seller to say, "You know what? I don't care if it's a third, give me my money. Get me out of here."
Q: How long can rates stay this low?
A: I've seen plenty of cycles. And interest rates, since I've been in business, have never been this low. You've got a 10-year Treasury at 3%. You've got mortgage rates for 4% and 5%, a jumbo is 4⅞%, You've got tremendous interest rates. We've got to wait until the Fed stops QE2. When the Fed stops buying bonds, you should see some escalation in interest rates and some drop in the price of bonds because the biggest element of demand is going to leave the market.
Q: Do you think we'll see QE3?
A: It would be an awful tough one. We have been told of the politics and the deficit focus, so there's no more beer to go around anymore. We can't spend our way any longer out of the problems that we've got without really roughing up the system to an extent that it may become dangerous. I don't see QE3, and I don't see additional stimulus out of the administration being possible. You can't reduce the deficit while starting another program to stimulate the economy.
Q: But even if we were to see rates back up a little after QE2 ends, you're still looking at a very low level, right? So aren't we talking about low rates for an extended period?
A: It very much is determined by items beyond our control. We don't know what's going to happen in the oil market from day to day. The Middle East. We don't know if Greece collapses. If it does, does it take with it Portugal or Ireland or Spain? We don't know what the world holds for us, So I couldn't say that interest rates should stay low. I would have no problem believing that interest rates on 10-year Treasury could go from 3% to 4% to 5% in a space of two years. And if interest rates are 5% on a 10-year, your mortgage is going to be 7% or 7½%. We existed for 40 years with an average interest rate for mortgages at 8½% and thought we were doing pretty well. Q: How hard is it to get a mortgage right now? Are banks lending?
A: Well, if you really don't need the loan, you can get it in a minute. If you've got decent credit and you're going for an 80% mortgage, there's no problem whatsoever. People will chase you all over town trying to get that to you. If you're looking for an all-pay as opposed to prime, you're going to have a little more difficulty. Anything other than prime or alt-A (the next riskiest) mortgage, yes, it's difficult. But that's not what's restraining the market.
Q: What is restraining the market, then?
A: It's fear, a lack of confidence in home prices. You've got an awful lot of talk in the media, discussing whether house prices are going to go down another 5%, 10%, 15% or 20%. I think time heals all. And we believe that down the road, we are going to go back into what was a normal housing market for a long, long time in the U.S., which is that housing goes up in value every couple of years. We're not helped by discussions out of Washington that we ought to consider putting the GSEs (government sponsored enterprises) out of business, Freddie Mac, Fannie Mae; we ought to consider lessening the mortgage deduction. It doesn't matter whether you do put the GSEs out of business, and it doesn't matter if you do take away some of the mortgage interest rate deduction, as long as you give us a static situation where people know what the rules of the game are. Right now, people are confused. Q: Can you walk us through the country and tell us where the strong spots are for housing and where there still are troubled spots?
A: Oh, sure. Trouble spots for housing are Vegas; Phoenix; for more expensive housing, Chicago; inland empire in California; Georgia, Atlanta. Better markets are Massachusetts down through Washington, D.C.; Raleigh; Charlotte; surprisingly, Texas, Dallas, Houston,San Antonio . Austin's a little rough. I think that's about it.
