Interest rates have been a concern for potential homeowners, investors, and lenders for quite some time. Most homeowners focus on changing mortgage rates because they have a direct influence on real estate prices. However, this isn’t the only reason they are a growing concern. Interest rates also affect the availability of capital, as well as, the demand for investment. Interest rates can greatly influence the supply and demand for property and therefore property prices as well.
According to Investopedia, “Interest rates also affect returns on substitute investments, and prices change to stay in line with the inherent risk in real estate investments. These changes in required rates of return for real estate also vary during destabilization periods in the credit markets. As investors forsee increased variability in future rates or increase in risk, risk premiums widen, putting increased downward pressure on property prices.”
Booms and dips
When interest rates affect capital, it is likely that renting becomes more attractive. If you know you will not be able to afford the home you want, long term, due to interest rates and other economic factors, chances are you will turn to renting instead. This, in turn, drives the rental market to seek higher prices, as the demand increases, but will this hold true over time? Some industry experts have weighed in with their thoughts as to whether or not higher interest rates will result in lower real estate prices and higher rents in real dollar values:
John Souerby, a real estate broker in San Francisco, stated, “Higher interest rates typically create real estate booms, which include higher property values and higher rents. Right now, private investment (banks, insurance companies, institutional investors) in real estate is low because interest rates are low. Investors have moved their dollars out of the mortgage market to where they can get a higher return (they call it ‘flight to quality’). So, what happens when rates increase? Private investors move their money back to mortgages. The influx of mortgage money typically allows more people to buy, which leads to more competition for listed properties, which leads to higher prices.”
Christopher Telles, CRE professional, stated, “Historically, real estate rents rise with increases in interest rates. I’m not an economist so my views can be taken as conjecture, but as a student of interest rates and macro economics it is my opinion we will not see substantial increases in interest rates for the foreseeable future. China’s banking system, which is also being manipulated by their government, is in such a shambled mess that the US regulators, the FED, will likely have no other alternative but to continue to keep interest rates near their current levels as a lever to keep the trade imbalance in check and GDP levels stable.”
What does the future hold?
We’re likely to see the onset of a recession over the course of the next 24 months which will exacerbate the FEDs need to either extend further QE or at a minimum keep interest rates low to protect the strength of the US dollar.
My take is we are living in a new normal where interest rates remain low and as a result a cap is placed on GDP growth. Organic GDP growth is needed by industry to fuel business growth. Without growing businesses there is likely no way for real estate value to continue to rise.
QE placed money into circulation which allowed real estate value to bounce off their Great Recession bottom, but now that markets have fully recovered we’re beginning to see market prices remain flat or begin their decent. The east coast is seeing downward price movement. The historical pattern in a down cycle begins in the east and moves west.”
Ray Ciampaglia, a New Jersey Realtor with a Wall Street background stated, “The short answer is ‘yes.’ If the cost of money increases then the amount one can spend is on the item being purchased with borrowed funds is reduced. Therefore, buyers can afford less. This makes renting more attractive and in higher demand, increasing prices in rental markets. There are exceptions to this, but they come with a very rare set of economic circumstances.”
Chris Nicholson, economist, stated, “All other things (including inflation) being equal, yes. Although the net impact of rents is less clear than the net impact on asset values (valuations would go down for sure, but the rents go up with interest but down with valuation (which goes down when real rates go up), so more complicated).
From all angles
Some of the things that might NOT be equal and, therefore, could move prices in the other direction: local and regional occupancy rates, expectations about future real estate prices (terminal value), expectations about inflation, and expectations about risks and returns in other asset classes.”
Now that some other industry insiders have weighed in with their opinions, how do you feel about higher interest rates? Do you think it will influence rental prices?