3 Effects of Rising Interest Rates on Real Estate
The real estate industry is one of the most promising in the world. However, the COVID-19 pandemic and monetary excesses in response to the same have led to an unprecedented rollercoaster in the US housing market.
At a time when many businesses were forced to shut, and commerce was severely hindered, median home prices across the country soared from between 50% to 73%, with home values out-earning people in 25 out of 38 major US cities.
The two years of COVID-19 were a blessing in disguise for home owners and real estate investors, who took advantage of rising home values and rock-bottom interest rates to refinance their properties. In fact, cash-out refinances in 2021 reached a record $1.2 trillion, the highest since 2005.
Now that the mania has ended, and the Fed has turned hawkish with the highest interest rates in 15 years to tackle inflation, what lies ahead for the housing market in general, and real estate investors in particular? Will there be a soft landing, or a crash and burn?
What The Past Teaches Us
Historically, during periods of monetary tightening, real estate prices have not only held their ground but have massively outperformed equities and debt markets. If anything, cycles of tightening have helped stem the rise in housing prices, but haven’t made much of a dent when it comes to cooling down real estate values.
There will be a steady decline in new home sales, mortgage originations, and real estate deal-flow, but this doesn’t always translate into lower prices. A phenomenon often referred to as the ‘Paradox of Real Estate.’
Even though there has been a steady increase in active home sale listings and a marked decline in prices on a month-over-month, prices still remain elevated year-over-year, and there is a slim chance of home prices returning to pre-COVID levels.
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The Impact On Borrowers
Borrowers who opted for home-equity lines of credit (HELOCs) or adjustable-rate mortgages will feel the pinch of rising rates as soon as two billing cycles. This means their payables will likely increase, putting substantial pressure on cash flows, especially for real estate investors.
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For those with fixed-rate loans, however, the Fed’s benchmark is hard of any concern, and if anything it is the 10-year treasury yields that determine mortgage rates for such borrowers. The high rates, however, will dissuade new homebuyers, substantially cooling demand in the market, so it isn’t a great time to be a seller.
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What This Means For Real Estate Investors
While there are a number of segments in the broader real estate market that are currently in the doldrums, rental property investors are certainly not among them.
This can mainly be attributed to the fact that the rising rates have priced out a number of would-be homebuyers, forcing them to continue on as renters. This has kept the market for rental properties, especially multi-family rentals buoyant.
A long-term investment in a multi-family rental property still remains one of the best investments, even with current home loan rates, as rentals, which rose alongside home prices during the pandemic, might never go back to normal unless there are substantial supply-side interventions.
Other Factors To Consider
We are currently witnessing a unique situation in the market, with a number of factors beyond just interest rates weighing-in. This includes high levels of migration across the country, with remote work continuing to persist, and millennials reaching their peak homebuying age, contributing to the already elevated demand.
Cities on the Sun-belt in Texas, Florida, and Arizona have witnessed an unprecedented influx of new knowledge workers, which will likely keep both home prices and rentals buoyant for years to come, irrespective of how interest rates change.
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It is seemingly unlikely that the Federal Reserve will hike its way into a recession this year, so we’ve essentially seen the end of its hawkishness, and once inflation starts to cool, we should start seeing interest rates move back to normal.
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