Introduction:
What influences interest rates have and what a rise in interest rates means for the real estate market are explained in this article section.
Interest rates significantly impact the current value of future cash flows, which is why they are so important in the evaluation and performance of any investment. The Federal Reserve’s unprecedented efforts in the wake of the 2008 financial crisis resulted in a quantitative easing program of more than 2 trillion dollars, the largest in history. Therefore, investors should be mindful of the potential impact that rising interest rates can have on their portfolios at this time.
Here, we explain what influences interest rates and what a rise in interest rates means for the real estate market.
Where does this increase in interest come from?
The four main factors influencing interest rates are from the Federal Reserve (the monetary policy), bond supply, bond demand, and inflation.
Consumers feel that they will lose purchasing power as inflation predictions rise (i.e., their money will be worth less). To compensate for the apparent loss, interest rates rise. In the bond markets, increased supply can also contribute to higher interest rates since issuers are forced to borrow at higher interest rates due to supply and demand dynamics. If demand for bonds declines, issuers will have to offer investors a more significant return to acquire cash, resulting in higher rates. The Fed tries to manage the market by buying and selling assets to try and influence these forces. Although the Fed intends to lower interest rates by purchasing bonds (oversupplying the market with capital), this move can also enhance inflation expectations, thus offsetting any influence on interest rates.
When the need for money or credit increases, interest rates go up and decrease when demand decreases. The reason is that interest rates are a function of supply and demand. While an increase in credit availability will lower interest rates, a decrease in credit availability will raise interest rates.
A rise in the quantity of money accessible to borrowers boosts the amount of credit available to them. In the case of a bank account, for example, you are lending money. Depending on your account type, the bank can use the funds for its business and investing activities. As a result, the bank may be able to lend that money to other clients at a later date. In other words, the more money banks can lend, the more money the economy has to work with. The price of borrowing (interest) reduces as the quantity of credit grows.
Lenders are delaying repayment of their loans, which reduces the amount of credit accessible to the economy. For example, suppose you postpone paying your credit card payment until the next month or even farther down the road. In that case, you are increasing the interest you will have to pay and diminishing the amount of credit available in the market. The economy’s interest rates will rise as a result of this.
How does this affect the value of the real estate?
Real estate’s response to shifts in interest rates is straightforward and unambiguous when considered a stand-alone variable. In the end, the value of an investment is equal to the discounted present value of all of the future cash flows generated by that investment.
With rising interest rates comes a decline in the asset’s future cash flow value (real estate property). In other words, increasing interest rates make any investment less enticing since investors demand a more significant return, even if the return on that individual investment is the same.
Rates don’t move in a vacuum; there are always other elements at play that could impact the value of real estate in addition to rate fluctuations.
Inflation and rising interest rates have a more complicated relationship in real estate. For most, inflation drives interest rates, and the two tend to rise and fall together.
Conversely, inflation can raise the value of hard assets like real estate, a hedge against rising interest rates. In the end, a favorable outcome is possible if inflation raises the value of a home more than the inflation rate decreases its worth. Since it can withstand rising interest rates, real estate is one of the most sought-after investment classes during periods of inflation.
What’s in it for investors now?
The unprecedented purchase of over $3 trillion in assets by the Fed as part of its quantitative easing program has established a new record. It’s worth noting that the purpose of QE (quantitative easing) was to keep asset prices stable, thereby preserving demand and lowering their yields.
Many people were surprised to learn that despite the enormous amount of money the Fed has pumped into the economy, there has been little to no inflation. For others, banks’ unwillingness to lend is the cause of the low level of inflation we’re experiencing. A steady economic recovery has many predicting that banks would expand lending, leading to a rapid inflation rise. Interest rates could rise significantly if the Fed scales back its asset purchases in conjunction with this.
Investment decisions should take into account the likelihood of rising interest rates. Most fixed-income assets do not provide the same level of inflation protection as real estate, which is why they are an essential aspect of a diversified portfolio. According to most experts, real estate is an excellent investment in today’s market because interest rates are expected to increase significantly shortly.
Supply and demand, inflation, and monetary policy all influence interest rates; thus, it is crucial to know how current interest rates are changing. So, of course, it is vital to consider the characteristics of debt security while deciding whether to invest in it.
******************************
Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.