People incorrectly assume that interest rates are the largest....
Many people incorrectly assume that interest rates are the largest factor contributing to the direction of the real estate market. Though changes in interest rates have an impact, a combination of related factors contributes to the overall health of the housing market.
As the Fed adjusts interest rates, capital flow is highly impacted. This can put pressure on the supply and demand for real estate, rental prices and yields for existing and future investments, required returns for new projects, and the value of properties in general.
As interest rates continue to increase in today’s environment, it’s expected that the cost of accessing investment capital will also continue increasing. However, rental market growth is still strong and is expected to continue growing, potentially insulating some of the negative effects of interest rate increases.
Throughout most of history, interest rate changes have been made in response to existing economic drivers and trends. The interest rate changes themselves don’t necessarily create trends, but they tend to steer the economy as it follows an existing trend. For example, the Fed quickly instigated dramatic interest rate reductions and participated in quantitative easing following the 2008 market crash to stabilize the downward economic spiral. Changes were made in response to an external event.
There is no precedent in history for the exact circumstances the Fed is currently dealing with. Interest rates have changed by similar amounts in the past, but they did not start at the incredibly low rate that the Fed reached in recent years. Changes of at least 1% over a year have happened six times since 1990, according to U.S. News. None of the beginning rates started as low as the beginning rates for the current environment.
Furthermore, mortgage rates are still at historic lows, despite rising interest rates. In previous years, house price appreciation continued to grow, although home sales often slowed.
Predictions vary as the market takes on some uncertainty. Typically, we expect to see mortgage rates rise, new real estate investments decline, capital values increase, and yields stagnate or reduce. However, rising interest rates have not been adversely affecting the market thus far and are not projected to have as large of an impact as other times in history.
Because the bottom rate was so low, to begin with, interest rate increases have brought the Fed’s rates up to previous averages rather than new highs. Mortgage rates have remained low and are not expected to rise significantly unless new investments taper off. Currently, investors are still buying real estate, though there is some reduction expected as capital value increases.
Experts believe other economic factors are responsible for the current strength of the real estate market, including low unemployment and millennials entering the housing market. This has influenced housing prices and continued the growth in home purchase and rental prices. Therefore, yields and ROI have not seen a hugely negative impact from interest rate increases so far.
However, home sales may slow if mortgage rates increase and as home values continue to grow. If this happens, there may be some constriction in the market as real estate investment slows to match new supply and demand trends. It’s likely that any major changes to the real estate investment market will be cushioned by a strengthening economy at large, removing the possibility of catastrophic market failure.
Rising interest rates have a visible impact on real estate markets, but they are not anticipated to damage the market in upcoming years. As the economy grew and strengthened following the 2008 market crash, the Fed’s move to increase interest rates was expected. Growth in rates through 2022 is projected, but the full impact will not be realized until the economy settles into the new rates and fully adjusts to the changing marketplace.
