Fed Rate Hike vs. Housing Prices

[Franco Li]

We have all lived in a very comfortable environment of low-interest rates and quantitative easing/easy money policies for a number of years, and this has benefitted both home owners and ordinary real estate investors with low leverage costs. However, interest rates can only remain so low before the market starts to overheat, and with a stronger economy based on recent job numbers, the Federal Reserve Bank ("Fed") will inevitably start to revert back to a "normalized" interest rate target.

Going forward, the Fed will probably raise rates at about 25 bps (0.25%) per quarter. In 2017, their target was to raise rates at least 3 times, and with the latest March announcement, the wheel is already in motion, as the rates were raised from 0.75% to 1.00%. There will likely be 2 additional rate hikes this year.

What does that mean exactly?

By raising the federal fund rate, the effective benchmark rates of mortgages will go up as will lending prices overall. Future mortgage rates will probably be even higher than they are currently, and may have a negative impact on any real estate investments as cost of funds increase - mostly those with ARMs or are looking into a mortgage in the future. The intelligent investor should try to lock in a lower interest rate now to take advantage of cheaper leverage costs before debt costs go up.

What does this mean for the housing market?

Theoretically, rising interest rates will slow down housing sales and potentially bring down prices a bit. During a low interest rate environment, individuals were motivated to take on mortgages due to the affordability of debt, and poured into real estate investments across the country; and therefore driving up prices in certain areas. With a reverse in interest rate direction, this may have a medium-term effect on housing prices. Locations where margins are already very tight may see demand drop altogether, which may depreciate home values in these areas. Still, investment-positive locations will likely have a price floor (i.e. smaller cities), and thus should not expect to suffer heavy (or any) losses.

There are other factors that drive the housing market.

Perhaps a more meaningful aspect of how prices are driven in the housing market - aside from interest rate movements - is a stronger economy. There are multiple factors when predicting where house price movements will trend, but a stronger economy (which is the driving force to end easy money policies anyway) may have a stronger impact on the housing market than the interest rate factor.

With more money in the pockets of an average household, there might be enough demand in the housing market to offset the rising cost of leverage. This is a likely scenario, and as the rising rate transition happens over the next couple years, we may see housing prices go up in certain neighborhoods that are hotspots for ownership and investments, as folks move quicker while rates are low.

Refinance ASAP.

If you have considered or are considering to refinance any properties, now would be the best time. For the foreseeable future, interest rates will likely rise into 2019/2020, so any leverage cost would go up. Lock in the still-low interest rates that are out there immediately before experiencing higher costs in the next 6-months to a year.

In any case, there are limited hedges for the average real estate investor, but if prudent leverage and investment strategies were taken before the hike, any interest rate movements should not have much of an impact. 

Welcome any thoughts on this matter, or if anybody has a different view.