When considering an investment in general or real estate investment in particular, the interest rate is one of the critical metrics to evaluate because of its impact on the profitability and the present value of future cash flow. When interest rates fluctuate, not only do property markets and house prices change, but there is also an effect on capital flows, return on investment, supply, and demand. Investors are aware of the potential impact of interest rates on their portfolios, as interest rates rise could provide a cheaper asset-buying opportunity.
There are four main factors that cause the change in interest rates: inflation, bond supply, bond demand, and the Federal Reserve. As inflation increases, consumers’ purchasing power decreases due to their money being less valuable, leading to an increase in interest rates to compensate for the loss. Moreover, if the bond market supply increases, issuers are forced to borrow at higher interest rates, leading to higher interest rates. Conversely, if the demand for bonds decreases, investors will receive higher returns from issuers to raise capital, resulting in higher interest rates. Finally, the Fed tries to control interest rates by buying and selling assets to keep the market in balance.
Changing in interest rates directly affect real estate prices. When interest rates rise, the value of current cash flows in the future decreases, causing the value of the property to decrease. A simple way to understand is that when interest rates are high, investors expect higher returns, so real estate becomes less attractive because the return on the investment remain unchanged. Another explanation for this inverse correlation is that the real estate market based on the mortgage loan or credit line. When interest rates rise, which means higher borrowing costs, buyers will find it difficult to qualify for loans, resulting in lower property prices due to less supply of money.
In real estate, it is important to consider the relationship between inflation and interest rates as they change together. Although rising interest rates cause cash flows to devalue, inflation in turn does increase the value of assets. If the increase in assets by inflation is greater than the decrease due to an increase in the exchange rate, the net result is likely to be positive.
Overall, besides the price of real estate, interest rates are an important factor to consider in any investment decision because they can affect the amount of available capital. Along with the ability to protect against inflation of real estate, interest rates contribute to maximizing profits, making the investment portfolio becomes more significant.
Author: Vy Yakushenko
Kevin. (2017, October 13). How Interest Rates Affect Real Estate Prices. ModestMoney. Retrieved from https://www.modestmoney.com/interest-rates-affect-real-estate-prices
The Effects of Rising Interest Rates on Real Estate. Fundrise. Retrieved from https://fundrise.com/education/blog-posts/the-effects-of-rising-interest-rates-on-real-estate