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The Impact of Higher Interest Rates in Real Estate Investing

Oct 24, 2019 - by Erik Carrier

The effects of higher interest rates can have a chilling effect on real estate investment, but it doesn’t mean you can’t insulate yourself from the cold.

Real estate investment has never sailed on a sea of tranquility. Sometimes the waters can get a little choppy. And sometimes a strong storm can send your entire investment adrift. Those are the risks. But even with the occasional roller-coaster rides that come with financial investing, real estate is still the largest asset class, outranking stock and bonds combined.

Let’s face it. No investor likes it when the markets take them on a rough ride. Especially if you’re investing in real estate. You’re at the mercy of fluctuations in mortgage rates, occasional labor disputes, tax and liability issues, ever-changing interest rates and housing marketing costs, to name just a few items. That all being said, investing in real estate is still a time-honored way to build a solid financial nest egg for the long term.

For purposes of this article, let’s just focus on two items – interest rates and mortgage rates as they pertain to the real estate marketplace.

Mortgage Rates vs. Interest Rates

As most potential home buyers already know, if you’re looking to purchase a house or invest in commercial property, the best time to do so is when mortgage rates are low. A mortgage rate is the rate of interest charged on a mortgage. The financial lender who writes the mortgage also determines the rate of interest, based on many factors, including the buyer’s individual credit history. Mortgage rates come in two basic forms, fixed (each payment is the same) and variable (each payment is different, based on whatever the current interest rate is). The lower the mortgage rate, the attractive the property is for purchase. In short, knowing the current mortgage rate used to be the only thing most potential homebuyers needed to know before they began house hunting.

Not anymore. According to a recent article in Investopedia, what affects mortgage rates now more than ever is the perception of how healthy interest rates are at the time of any potential property purchase. The article states that interest rates have “as profound an effect on the value of income-producing real estate an on any investment vehicle.” Why? Because unlike straight-ahead mortgage rates, interest rates affecting the real estate industry are determined by many factors, including competition from other investors promising more attractive ROIs to lenders, the current rates for Treasury bills, interbank exchange rates, and other factors.

What Are the Effects of Higher Interest Rates on Real Estate Investment?

In simple terms, when interest rates rise, it makes purchasing a new property more expensive, since the bank loan that you’ll need to seal the deal will now cost you more. Conversely, if you’re trying to sell a property, a rise in interest rates can make the purchase less attractive, forcing you to either lower the asking price or simply expect fewer offers.

However, rising interest rates can have a positive effect on one sector of the real estate industry…the rental market. When interest rates rise and homes become more expensive to buy, the “winner” can be rental property owners. Why? Because if potential homeowners can’t afford mortgages at the present time, they still got to live somewhere. What's more, even a one percent increase in interest rates can translate into a profit windfall for rental property owners who are in a position to capitalize on this market fluctuation.

What Are the Disadvantages of Lower Interest Rates?

An article in the Houston Chronicle points out that while lower interest rates makes money more accessible, it also means that consumers are more likely to spend, not save. And as we all know, if you’re planning to buy a house or other type of property, that means that “saving for a rainy day” is not just an expression – it’s a necessity. Also, when interest rates are low, banks get more choosey as to who they lend money to. Typically, that freezes out smaller asset customers, while banks lavish their attention on clients with higher net worth.

In conclusion, interest rates and housing marketing are very much intertwined. Keeping one’s sights on mortgage rates is certainly important, but also maintaining a watchful eye on other financial indicators, such as interest rates is an absolute necessity in today’s competitive real estate marketplace.