In what ways will the Fed raising interest rates impact REI?

Question

I just noticed today that the interest rates on conventional mortgages went up by 25 basis points. In what ways will rising interest rates impact Real Estate investing? Should there be any concern for those that don't locked in a low interest rate?

Malcolm Douglas · Answer

Just want to point out that mortgage rates are correlated with 10-year treasury bond yields, not the FED funds rates (which I believe is what the hike talk above is referring to). If Yellen increases FED funds rate by .25% in December that does not mean Mortgage rates will necessarily increase .25%.The current ten-year treasury rate is around 2.35%. This got below 1.5% during the summer showing a difference of .85%. The FED did not increase rates during that period but mortgage rates most definitely climbed.This was something I did not realize when I first started but I feel it is important to know from a finance perspective.

Russell Brazil · Answer

Rates are up 2/3 of a percent in a week and a half. Early next week I'd expect it to hit 3/4 of a percent from a couple weeks ago. This is with the Fed having done absolutely nothing. I don't see any roadblock to stop the short term sell off of the bond market. If someone told you a few months ago interest rates could spike 1% in under a month, you would have thought they were crazy, but right now that looks to be what is very likely right now.

Chris Mason · Answer

Retail owner occupant first-time homebuyers flip out when rates change by just a little bit, and are often obsessed with trying to time markets. So some chunk of them may stay on the sidelines longer, waiting for that mythical time when rates and home values are both down -- which is actually great news for landlords, because they still need somewhere to live while they tire-kick.As those late 20s early 30s non-FTHB sit on the sidelines for longer, there are still people graduating college, high school, etc, moving out and needing places to rent. So net demand for rental housing may go up (fewer people leaving the rental market, continued stream of persons entering it), which in turn would of course increase rents, possibly offsetting the moderate cost of the higher interest rates. I will be very shocked if the doomsday preppers predicting 8% within 12 months are correct.

Andy D. · Answer

That is a good bottom line of looking at the future, yes. If interest rates are basically at 0 then there is only one way in the long run: up. And they will go up, no doubt. Whether it's a (small) hike in December or only in January, we'll see.Then again, a .25% rate hike will not have much of an impact. Do the math: let's say you, as a consumer (not investor), finance your primary residence of 200k with 5% down, i.e. you need 180k from the bank. Further assume that currently you will get that amount for 3.5% interest rate (per annum). That's an annual interest payment in the amount of 6'300. Per month that's 525.Now calculate the same with 3.75% because that's how much the bank increased the rate due to a .25% rate hike by the Fed (this is very simplistic and will not translate 1:1): total annual interest is now 7'200, that's 600/m. That's an additional $75 per month on a 200k property. IF this breaks the bank for you on that property then you shouldn't have bought it and financed it the way you did. At least in my opinion.Now look at a typical investor, because there will be a difference. Why? You will never get by with only 5% down. More realistically it's 15-20%. Why is that relevant? Because you will need a smaller loan on that 200k property. You can run the math yourself. Bottom line: the difference is negligible in this context. And since these things are relative, it also hardly makes any difference when the figures get bigger. Because then you would have, overall, typically more money somewhere and wouldn't be bothered if the difference was tenfold. Again, simplifying things.Long story short: such a small rate increase will not make a noticeable difference. But the .25% will only be the beginning. It will continue (in that regard I'm with Bill) and at some point we'll have - overall - some .75% or even 1% in the next couple months. And that's when things will definitely start to have an impact. The impact will be as Bill has described above.Oh, and that's perfect for me as an investor as this only means more inventory for me to chose from as fewer people will be able to get financing, therefore less people will buy houses (= more for me) and might even have to sell (=even more for me to chose from) (leaving aside a delayed decrease in new construction). And how can I afford to still buy with increased interest rates? Because I don't leverage up to my eyeball and my ("cash-flow") figures work out.I would even go as far as saying (again, somewhat simple): a serious real estate investor doesn't care much about interest rates. But that might be a somewhat bold statement. ;-)

Darius Hollis · Answer

Ethan Schneider Interest rates directly affect the "cost of money" for investors using leverage via mortgages. As interest rates rise, purchasing power decreases because borrowing funds becomes more expensive. For investors who are using adjustable rate mortgages it is recommended to refinance into a fixed rate if it is reliably forecasted that interest rates will rise substantially.

William M. · Answer

Yes, because mortgage rates will only go up from here.

Ethan S. · Answer

@Andy D. Yeah, I agree with your calculations for the payments and interest for each period. But wouldn't the aggregate amount of interest add up to large amount over a period of 5-10 years. Taking a glance at the amortization schedule.(@.25% increase) Paying $75 x 60 months = $4,500 (Not discounted) (@.25% increase) Paying $75 x 120 months = $9,000 (Not discounted)I know that's really not much but say if the increase was greater than .25% to something like 2.0%.From an investors perspective I'm assuming a growth in interest would not make a difference because you could eventually write off most of the interest from the taxes by straight line depreciating the asset? So regardless if interest rates went back to what they were in the 70's or 80's it wouldn't really matter for an investor? Or the Mortgage Mechanics and can be a pretty confusing thing..so I'm understanding...1. Consumers perspective (Buying a home) = This kind of sucks. Future consumers will be paying more to banks for borrowing money. 2. Investors perspective (Purchasing an investment) = Doesn't really matter3. Do not highly leverage yourself with debt

Andy D. · Answer

@Bill Gulley I agree with what you describe. I just don't agree with your prediction of 7-8% end of 2017. ;-) But that is really somewhat beside the point as your main point remains. And ultimately it makes no difference - in that respect - if it's 3% or 7%. It will change the current (investment) environment (in every aspect, not only RE) significantly. And I consider that a good thing.*makeremindertocheckforfedinterestrateindecembertwothousandseventeenandthenwritetobillitoldyouso* *g*

Bill Gulley · Answer

Yes @Ethan Schneider, it would be better for savers and investors. Depends which side of the fence you're on.@Andy @Andy D.undefinedBeing in Zurich might reflect an unawareness of our current political expectations here, it's not always the FED who leads, there are times when they must follow the market demand. If a bank has a Fed rate of 3% and they can lend at 8% they are having a good day, the Fed will close that gap eventually. After the GAO analyzed the administrations annual plan they estimated a -124% deficit in 10 years, it is the uncertainty in the market, reduction in the tax base, expansion of the infrastructure and trade modifications that can stir the pot quickly. Check back in a year, we will see where we go. :)

Ethan S. · Answer

@Andy D. Yeah it is pretty obvious that financing will be more expensive as time goes on. I'm still learning about all the different methods of financing deals. Seems like the longer you search to find a deal the more expensive financing will soon become as a result of the fed.