Why Rising Interest Rates = Higher Rents

Source: Alexander Grey on Unsplash

Let's delve into the topic of rising interest rates, shall we?

We're currently witnessing a financial landscape that hasn't been this tumultuous since the inflation peaks of the '80s. This shake-up, largely fueled by the aftermath of the COVID-19 pandemic, has seen interest rates leap from the comfort zone of around 3% to the much steeper territory above 4%.

But for landlords navigating the rental property market, this shift isn't just a challenge; it's a golden opportunity to boost profits by adjusting rent rates accordingly.

Interest Rates Making Drastic Changes to Cap Rate

Now, as rising interest rates put homeownership further out of reach for many, the demand for rental properties will correspondingly increase, also.

As these changes take effect, we’d encourage landlords to dissect their local markets meticulously. In particular, you need to consider how the rising interest rates affect your capitalization rate.

On average, a 1% increase in interest rates corresponds to a 10% increase in cap rate.

Yes, you read that right.

If interest rates rise by 1%, landlords could increase their cap rate by 10%.

Why do higher interest rates have such a potentially large impact on rental investors’ profitability?

Here are a few reasons:

Increased Borrowing Costs: Higher mortgage rates mean higher monthly payments for property owners who finance their purchases. This can reduce the net cash flow from a property, potentially making investments less attractive for those without cash in hand. That means less competition amongst investors, which means landlords could be able to acquire rental properties at more favorable prices.

Market Dynamics: In a rising interest rate environment, many potential owner-buyers may similarly be priced out of purchasing properties, decreasing demand. This can put downward pressure on property values while NOI remains unchanged or grows marginally, resulting in higher cap rates.

Rental Income Adjustments: Given that more people will be postponing home ownership, there could be increased demand for rental properties. Accordingly, landlords might increase rents to maintain their desired yield, especially in strong rental markets. However, there's a limit to how much tenants can afford, and significant rent hikes could increase vacancy rates, affecting NOI.

So, rather than viewing rising interest rates as a setback, savvy landlords can see them as a strategic advantage.

Seizing the Moment

In summary, while higher interest rates may seem daunting at first glance, they present a unique opportunity for landlords willing to adapt.

By recognizing the shift towards rental preference and recalibrating rental rates in response to changing cap rates, landlords can unlock new avenues for profit. In this ever-changing real estate landscape, flexibility and strategic planning are key to transforming potential challenges into lucrative opportunities.

Our team of property managers in the Metro Detroit area are experts at maximizing the income you receive from your rental properties. to find out how we do it.