Average 30-year fixed-rate mortgage interest rates have gone up this year from 3.375% in April 2021 to currently 5.11% as of April 2022.
This was due to the Federal Reserve voting in March to start lifting its benchmark federal-funds rate by a quarter percentage point to a range between 0.25% and 0.5%. This is the first rate increase real estate investors have seen since 2018, and six more increases are potentially scheduled to take place by year’s end. While it might sound crazy, the federal reserve is taking an aggressive approach to raising rates to combat inflation that is running at its highest levels in four decades.
Why Does This Matters for Rental Real Estate Investors?
The “rate” that everyone refers to is actually the “federal-funds rate”, which is a rate on lending among major banks. When this rate goes up, borrowing becomes more expensive which slows down spending and slowing down rising inflation. Conversely, lowering rates can encourage more borrowing and lift up a struggling economy. It is essentially a balancing act of the right amount of growth, but not too much.
This rate influences other consumer and business borrowing costs throughout the economy, such as credit cards, saving accounts, car loans and corporate debt and most importantly – mortgages.
Theoretically, when the cost of getting a mortgage goes up, less people can afford it and real estate purchases slow down. When purchasing slows down, prices start to fall.
This has both positive and negative implications. We explore some of each below:
The Good of Rising Rates
Let’s remember that the Fed is only raising rates because of the high inflation. While everyday staples such as gasoline and groceries have gone up, so have the prices of properties. If you had been holding onto rental real estate almost anywhere within the United States since at least 2019, the price of your assets would have gone up significantly too.
The powers that be (i.e. The Federal Reserve) publicly acknowledge that there is an issue and they are proactively taking steps to prevent another financial crisis like 2008. While some may still criticize their action as “too late”, a worse off scenario would have been to take a “hands off” approach and let inflation keep climbing into an unsustainable levels such as “hyperinflation”.
The Bad of Rising Rates
It’s true – Rising interest rates pull down property prices, which can lead to a recession. If prices fall too low, some property owners who have adjustable rate mortgages might not be able to afford their existing mortgages and can fall into default. Since the housing market is so tightly connected to a majority of middle class wealth, the effects can spread to many other sectors of the economy as well.
Acquiring new rental properties becomes more challenging due to higher borrowing costs. Investors are only willing to take on debt (i.e. a mortgage) if they believe they can leverage this debt to generate a profit on the property. If borrowing costs go up too much, profit margins shrink, reducing the viability of many would-be investment projects including rental property ground up construction builds or simple remodeling projects.
So What Does All This Mean?
Rising interest rates is something that rental real estate investors should definitely keep their eye on. If you are in the market to purchase, this will definitely have a major impact on your purchase capability. If you are in the “holding” phase, this can affect the “book value” of your investment should we slip into a recession. Either way, rental real estate investing is a long game and changes in the market , whether good or bad, eventually pass.