How Interest Rates Affect Real Estate by Ken McElroy

How Interest Rates Affect Real Estate

The Highs and Lows of Real Estate Investing

In my past blogs, I’ve touched on the different aspects that affect property values (i.e. supply and demand, property location, etc.)

But today I want to focus on interest rates and how they affect the potential profit of a property. To better understand how interest rates and properties are linked, we need to understand monetary policy. The central bank of a country has the power to control spending by adjusting interest rates; this directly affects the economy. When countries experience a period of rapid growth, the central bank adjusts interest rates to stop the economy from over-inflation. When interest rates rise, it forces consumers to hold on to their money which slows down the economy. On the flip-side, interest rates are lowered in hopes that people will start spending money to stimulate the economy.

So how does this affect real estate?

Interest is charged on debt financing. Debt Financing is when a company raises money by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions receive a promise to repay principal and interest on the debt.

Debt financing is often used to both purchase and build real estate. So, when interest rates are high, it implies that (a) there will be less spending or (b) there will be expensive financing for real estate projects.

If you are an investor who already has your eye on a specific property on the market, you’ll be interested in the interest rates. Again, if interest rates are high and you are using debt to finance your real estate deal, it may not be a lucrative return as higher rates tend to reduce returns. Lower interest rates tend to stir more real estate activity and create more lucrative deals.

When you look at this from a real estate developers’ point of view, the same relationship with interest rates apply. The higher the rates, the more expensive the deal with less returns. The lower the rates, the more affordable and lucrative deals seem to be.

Now, interest rates alone don’t give you the full story when it comes to the real estate market or specific properties. But it will help you understand how investors and developers see the market. When you understand how the other players are playing the game, it gives you an edge and your next move.

So what happens when we look at the big picture?

When we can see the big picture and can understand the changes in the economy, we can plan our moves. Let’s say that we have an expanding and prosperous economy. If that is the case, we can assume that interest rates will likely rise. When this happens, you may think the potential returns of properties would lower. However, this isn’t always the case. The economy is already expanding and higher interest rates are meant to reduce spending, but it doesn’t happen immediately. In some cases, property values in the past have continued to rise despite higher interest rates.

The opposite scenario can be just as true in the case of a declining economy. Property values could be on the decline when interest rates are lowered without an immediate effect. There’s also the possibility that property values could dwindle even further than expected.

The bottom line is: you have to look at EVERYTHING.

There is a slew of factors that come into play when determining a property’s potential profit. You can’t just look at interest rates alone. Today's market is filled with many opportunities for the savvy investor. If you’re interested in learning about some strategies that can help you launch your career as a successful real estate investor, consider reading my book.

Original publish date: August 14, 2019

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