How Will the Rise of Interest Rates Affect Real Estate?

The rise of interest rates is on everybody’s mind right now, and for good reason. The Federal Reserve has committed to bring down the 8.6% inflation rate to a normal level of 2-3% a year, and In order to accomplish that, the Federal Reserve opted to increase interest rates and reduce its balance sheet to slow down the liquidity in the market place and slow down inflation.

The Fed raised its benchmark interest rate to a range of 0.75% to 1% as of May 4th, with the expectation of further rate hikes over the next few meetings to tame down inflation. The hike in interest rate reduces liquidity in the market, and makes it more expensive to borrow money, which has caused the stock market to tank over the past few months, bringing the S&P 500 17.83% down this year, as well as shaving 28% off of Nasdaq this year alone. 

 

What About Real Estate?

The Real Estate market has gained tremendous amounts of growth across many sectors in 2021 due to low interest rates as well as the rapid rise of rents, low inventory, small amount of new supply, among many other things. Real Estate has been a clear winner over the past 2 years. The median home price across the US rose by 17% in 2021 per the National Association of Realtors, while apartment rents rose by 17.5% per ApartmentList.com, which tracks rental data across the US.

 

Those were record growth numbers we have not seen before, but does that mean we are in a bubble?

A “market bubble” occurs when there is tremendous growth without having any underlying fundamentals behind the growth. It’s important to realize that prices are determined mainly through supply and demand. According to Freddie Mac, as of late 2020, we have a shortage of 3.8 Million homes. Since then, the massive supply of homes shortage has only got worse due to the labor and material shortage we are facing as a nation. As a result of the lack of supply, and the ever increasing demand due to a growing population, as well as the migration patterns of people towards sunbelt states, housing costs have gone up due to massively increasing demand. 

Having said that, as interest rates have increased, buying a home has become increasingly more expensive to afford due to the fact that it would cost more in monthly payments due to the higher interest rates even if prices stayed the same. 

What I predict will happen as a result of this is that housing prices will rise at a much more modest level over the next year. It is very unlikely for us to see a year of growth similar to what we saw in 2021. As a result of higher interest rates and bigger mortgage payments, tenants will have a harder time qualifying for loans, which I predict will further increase continuous demand for apartment rentals, pushing rents even further. 

“Cash is trash, but equities are trashier” as Ray Dalio said on May 24th on CNBC when asked about his predictions of the market. “The question is, what’s going to get you a real return?”…”we have shifted into an environment where assets that do well, almost like the 70’s, are in those types of things, real assets, real returns” referring to what’s known as the Great Inflation of the 1970’s where inflation skyrocketed, interest rates rose, and stocks suffered significantly for a decade, while on the other hand, real assets like Real Estate were arguably the best performing assets, more than doubling in value from 1970-1982, moving up alongside inflation. 

As a final note: If you are buying Real Estate, I would highly recommend evaluating deals with the assumption that interest rates are going to continue to rise in the next 1-2 years, and setting aside a good chunk of reserves in the bank on top of that to be extra safe, or getting a fixed rate loan if available. 

If you are interested in looking at future Real Estate investment opportunities to invest passively in deals alongside us, click the link here to schedule a call to be added to our Model Equity Investor Club where you will get private access to limited investment opportunities as they become available! We have nothing to sell you on the call, it will be completely free with the intent of answering any questions you may have about passively investing in Real Estate.

*This is not financial advice. These are all opinions of the author which may or not turn out to be correct. Please do your own due diligence.

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