Interest Rates Effect on Real Estate
by Omar Ruiz
Why are Interest Rates Increasing?
Federal Reserve Chairman, Jerome Powell (Fed) has been on a mission to fight inflation since March of 2022. After erroneously describing inflation as “transitory” in 2021, the Fed now finds himself behind the curve. Facing the highest inflation since the 1980’s the Fed has repeatedly increased rates by an aggressive 75 bps. Now Interest rates effect on real estate has caused disruptions.
Some economists believe the Fed is overreacting by not sufficiently considering supply chain troubles that still affect inflation. The rise in interest rates effect on real estate and the economy as a whole is exacerbated by the Fed as a result. The thing most investors seem to agree on is the immense amount of money pumped into the economy for pandemic subsidies contributed to inflation.
Interest Rates Effect on Real Estate in the Current Environment (Short-Term)
Rising interest rates effect on real estate has been swift and making headlines. For an extended period of time real estate buyers got accustomed to low rates. Now that mortgage rates spiked, demand has fallen across the board for residential and commercial real estate.
New home builders are experiencing sales cancellations. Some builders have resorted to offer to pay down points to reduce buyer’s interest rates. The building industry is putting a hold on construction of new homes as demand drops.
Numerous transactions in the residential and commercial space have fallen out of escrow, leaving agents, brokers and lenders struggling to maintain business. Home sellers that are motivated and have to sell are adjusting expectations and cutting prices to move their homes. Investors buying commercial real estate have found themselves in an interest rate squeeze and cancelled transactions. Some investors have had to put more down payment money to close transactions, which lowers their return on investment.
Bridge loans were popular for multifamily acquisitions. Now bridge debt has become more expensive and less appealing as rates increase and leverage is reduced. They may be deliberately pricing themselves out to reduce their exposure to what they may perceive as a risky market. Existing borrowers of bridge debt with loans coming due may be challenged if they can’t refinance to cheaper debt or they may have to pay extra for term extension fees.
Numerous lenders have downsized, closed or gone bankrupt. The drop in loan demand and refinancing’s has caused the lending industry to retrench. Those still operating have reduced their head counts and costs to maintain operations.
As less people are able to afford to buy homes, rental demand will increase. Rents will go up as fewer homes are being built causing a supply constraint that was already pre-existing. This will be a positive for landlords as their cash flows will increase.
Long-Term How Will Interest Rates Effect Real Estate
In the short-term, the problem with the Fed continually increasing rates in dramatic fashion (six increases in 2022 with four increases at 75 bps) is it’s difficult for the lending market to adjust. Over the long-term it’s believed that once the Fed pivots or adjust downward, it will be a sign of easing from the Fed and path towards normalcy or reduced volatility.
There’s another line of thinking that the Fed will over compensate and increasing interest rates will cause the economy to go into a recession. This is difficult to forecast and the reason why real estate demand has dropped – buyers and investors are waiting to see what happens (us included).
The Fed will be led by the direction of inflation. If inflation drops this will be the sign the Fed is looking for indicating a change in interest rate policy. It may take multiple drops before the Fed feels confident enough that previous actions are curbing inflation. In the long-term this will help markets to normalize, stabilize prices and stimulate demand. These future interest rates will affect real estate by stabilizing values and increase transaction flow again.
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