The Fed's move has little impact now, but smart $ looks to 2018

[Scott England]

Hey friends!  I'm going to preface this post by saying I'm not an economist and only bring to the table what 10 yrs in real estate finance and investing, in a non analyst position, offers.  I'm no expert.  

That said, I read as much chatter as yesterday's schedule would allow concerning the Fed's rate increase.  Obviously, this is no surprise and most markets had already priced in such a move.  And the discussions I encountered were in agreement in that regard.  We've even seen a .25-.375 improvement in MBS prices since close on Wednesday.

But, I'd like to draw attention to the Fed's own projections for the median funds rate over the next 3 years. 

http://www.federalreserve.gov/monetarypolicy/fomcp...

That median puts the cost of funds at 3.4% vs 0.4%.  That's an enormous increase in a (relatively) short period of time, at least from the perspective of those of us who have most of our investing experience since 2000, during the glory days of low interest rates.  

If this is the case, it could have a significant impact on our portfolios, not just in 2018, but as rates continue to (rapidly) rise across all indexes.  

Now, this is by no means a doom and gloom warning and these are just projections, but I think it is important for investors to take some time to stress test their portfolios with that scenario.  

Here are some things to consider:

1) Adjustable rate mortgages, HELOCS and other non fixed loans.  These will be gradually increasing over the next 3 years.  Does converting or reducing those now make sense?  

2) Mortgages with shorter fixed rate a period than amortization.  5 year fixed with a 15 year amortization is a pretty standard structure for portfolio lenders.  What will be adjusting in that time and how will that impact cash flow and our return ratios. 

Local bank mortgages/Credit Union loans taken out in 2013-2014 on this structure will be around the 4.5-5.5% rate mark, at best.  If the projections are correct, what is the plan when those adjust to, say, 7.5-8.5%

3) How will the rising rate environment, in general, impact my investment strategy.  If my cost of funds is rising, then my rent rates or buy points need to as well, or I need to adjust my model.  And that is just for new investments.  How will my CURRENT portfolio perform in this scenario?  

I think looking at our properties collectively, at the portfolio level (even if you only have a few doors), is going to be important going forward.  We shouldn't focus too much on the performance of individual units so long as we have enough dials to turn at a high level to meet our return requirements during this (hypothetical) period of transition.  

4) Accessibility of financing and the movement of institutional funds to other markets.  There are 2 points to consider here:

- Rising rates is good for banks (generally speaking) because it takes pressure off of the margin squeeze they've had to deal with for years.  The more opportunity for margin outside of real estate, the less capital will be available to investors.  

- For roughly the same reason mentioned above, we could see a massive exodus of cash away from REITs and other RE investment vehicles, just was we've seen the massive influx over the last few years.   If so, what opportunities open up for the local investor?

I would love to hear everyone's thoughts, adds and critiques.  Please remember, this is a recommendation to run stress tests on our portfolios to a hypothetical (yet projected by the Fed) scenario, not a prediction.