The decade's fiery demand for homes as investments may soon be doused, dragging down inflated house prices and choking consumer spending, housing analysts and industry executives say.
Torrid demand to buy investment properties helped fuel the past five years of record home sales and propped the economy.
An unusual spike in short-term interest rates to match long-term rates will thwart many second home buyers who tended to use low adjustable-rate mortgages for savings or affordability. Whether for vacation, retirement, rental cash flow or the quick flip as home prices surged, the incentive to invest in homes is shriveling, experts say.
"The stats that we've all seen show anywhere from 15 to 25 percent of all home purchases right now are from investors and second homeowners," said Robert Foregger, chief strategy officer at EverBank in Stowe, Vermont.
"If you revert to the mean, you could have somewhere between maybe 10 and 20 percent of the market that could really just dry up," he said. "If it does, it has the potential to put more downward pressure on prices."
This decade's record sales pace and price appreciation are seen as unsustainable. Housing economists look for slowing this year, but still robust levels historically. An investor pullout is considered a major risk.
Nearly one-third of new home loans last year were adjustable-rate mortgages, or ARMs, which carry a low initial rate that later gets reset.
These loans, and more exotic and riskier mortgages, made investment home buying appealing just as home prices soared and the stock market seemed less of a sure bet.
But an inflation-fighting campaign by the Federal Reserve sent short-term rates up sharply in the past year and a half.
Fed officials have cited worry about aggressive lending and risky loans to squeeze people into houses they might not otherwise afford, putting a shaky floor under the sector when interest rates and thus loan payments rise.
Last week, for the first time in five years, two-year Treasury yields surpassed the yield on 10-year notes. The rate advantage of ARMS disappeared. Homeowners started the rush to refinance and lock in low rates with fixed-rate loans.
The pain will be felt by the new home shopper, home buyers already facing affordability problems and the home investor.
"In terms of the behavior of the new shopper, the ARM product was sort of the magic elixir for the consumer," said Foregger. It made housing affordable to people who were buying more house than their personal income would otherwise allow.
The share of ARMs used this year and last reached the highest levels since U.S. home funding company Freddie Mac began tracking it 10 years ago. It was about triple the lowest share of 11 percent, reached in 1998.
One of the most popular products is a 5/1 hybrid ARM that has a fixed rate for five years and then resets annually.
Freddie Mac said the rate could spurt by as much as five percentage points on the fifth anniversary. With short-term rates jumping, these loans make sense for homeowners who sell by then, but could otherwise be painful.
If the yield curve inverts more deeply and home price gains slow or reverse, ripple effects could be more severe.
"I think people who were trying to get into investment properties and trying to flip them won't see those financial advantages with the short-term rates being higher than the long-term rates," said Bob Moulton, president of Americana Mortgage Group in Manhasset, New York.
Home sales in recent months are already less steamy than in the five years that drove home prices up 53 percent nationwide, according to government data.
Some of the hottest markets had even larger gains, such as California, where home prices soared nearly 110 percent this decade. Sky-high prices in the most costly areas encouraged demand for ARMs and more exotic loans with lower initial rates.
"Buyers to be concerned about are those who couldn't afford a fixed-rate mortgage when rates were below 6 percent and opted for an interest-only or other adjustable-rate mortgage as a way to keep payments low," said Greg McBride, senior financial analyst at Bankrate Inc. in North Palm Beach, Florida. Many borrowers "won't be able to get the deal done like they could when short-term adjustable rates were much lower."
Business volume will slide but home prices are still more apt to fall regionally than nationally, he said.
An outlying concern is if "you start to get a lot of these markets like California and the Northeast all experiencing the same symptoms at the same time. That's a very bad sign for consumer spending and the broader economy," said McBride.