In all areas of real estate, market interest rates can have a large impact on various dynamics. Any shift up or down in these rates, and there can be considerable shifts in buying and selling perspectives from buyers.
Understanding how these dynamics work is important for anyone considering investments in the real estate market. Having this knowledge can mean the difference between making a smart, profitable decision and painting yourself into a corner with an aging property that’s hard to move.
Below, we’ll go over some of the more important things about interest rates that investors need to know.
How Interest Rates Work
Interest rates are dictated at a commercial level by national banks. These organizations establish a foundational policy rate that recognizes a number of variables and helps to steer economies in the right direction.
These rates eventually trickle through the market and influence the level of interest offered by banking institutions when providing mortgage and personal loans.
In real estate markets, the impact of these rates can have a significant impact on the cost of homes and overall value over time. They help to determine the level of financing that’s offered and can significantly increase or decrease borrowing costs for home buyers or investors.
Important Things Real Estate Marketing Investors Should Know About Interest Rates
1. Impact on Mortgage Affordability
If interest rates start to climb, this will directly lead to more costly home loans being provided. Increased rates typically mean borrowers need to have larger mortgage payments each month and can quickly eat into home-buying budgets.
As this happens, purchasing power for homebuyers also reduces, since they’re not able to offer the market value prices of homes, or they have too many more competitive offers they need to navigate around.
This issue also extends to individuals trying to sell their homes since the pool of qualified buyers is reduced, which can mean homes are on the market longer and decrease their chance of closing a sale.
2. The Effect on Property Values
Property values and interest rates have a push-pull relationship. When interest rates start to move higher in the market, this typically means that fewer buyers are able to secure adequate loans and make a purchase. Because of this, demand in the market can start to sink, leading to stagnation.
This inability for more buyers to enter the market shifts demand, which can directly impact property values, making them less. If, however, interest rates are lower, then the demand for purchasing new homes increases, meaning property owners can demand higher selling prices.
3. The Rental Market Conundrum
Rental markets are also impacted by interest rates. Higher rates typically mean potential homebuyers are limited to the rental market for longer than they’d like. This increases the number of individuals renting versus buying a property and drives demand higher for those who’ve invested in renting out homes or condos.
In situations where owners are able to bring in higher amounts of rental income, this can help to offset the costs of financing newer properties. This typically creates a “buy-and-hold” rental strategy opportunity, which can be a profitable investment choice in certain market conditions.
4. Influence on Investment Strategies
When interest rates are high, it costs much more to borrow the same amount of money. As a result, more rental properties become a go-to strategy. The steady stream of rental income helps to manage more expensive debt, all while providing a predictable and stable return on investment.
When interest rates are lower, often real estate strategies focus on appreciation. Since financing costs are lower than normal, investors can more easily access properties to sell for a profit in a short period of time. This typically increases the number of property flippers and custom project developers.
5. Cost of Home Renovations
For property investors who plan to buy fixer-upper units and put money into home renovation projects, interest rates can impact how they make these buying decisions. Most property renovations get financed through tools like Home Equity Line of Credit (HELOC), and any rate increases will impact the amount of capital investors can access.
This can also create a domino effect that impacts the amount of ROI investors can get. This happens because:
- Financing becomes more expensive, meaning a larger slice of the budget goes directly to the lender in the form of interest.
- The renovation budget itself is squeezed, leaving less money available for materials, labor, and unexpected overages.
- The overall return shrinks as the home renovation project cost climbs higher than initially planned.
6. Investor Cash Flow and Debt Service
When investors have variable-rate mortgages, they can have major cash flow issues. As monthly load payments increase, it can leave little room in the budget for additional property investments and can mean that property owners begin experiencing losses each month.
For investors, it’s critical to stress-test portfolios, especially in volatile markets, to get a better sense of how much risk they are taking before their investments suffer losses during economic downturns.
7. Builder and Developer Decisions
For real estate developers, interest rates can have a major impact not only on the total costs of their projects, but also on the timelines they can complete them in. As interest rates rise, the cost for getting financing for land, labor, and materials increases significantly. This can make planned projects financially unworkable, forcing many to hit the brakes prematurely until more stable market conditions appear.
Keep a Close Eye on Interest Rates and Their Impact
It’s important to remember that in real estate, often one market dynamic directly impacts the other. This is especially the case when it comes to increases or decreases in interest rates.
While the rise and fall of interest rates isn’t something that anyone can really predict, there are a number of signs that can suggest how they will change in the near future. By keeping up-to-date on the latest industry trends and having a strategic plan in place when investing in new properties, you’ll maximize your returns while minimizing your risk as much as possible.
Author Information
Author Name: Michael Alladawi
Author Bio:
Michael Alladawi, CEO & Founder of Revive Real Estate, is a Southern California real estate veteran with a proven track record as a builder, investor, and respected home flipper. Michael created Revive Real Estate to share his industry knowledge and help homeowners maximize their profits when selling their homes. Michael’s passion for his work is as big as his desire to create lasting partnerships. For Michael, it all comes down to how much value one offers, both in business and life relationships.
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