Navigating the Waves: The Impact of Interest Rates on Residential Markets, Part 1
I started this exercise by researching “free-market economy” and related ideas. What I found were some pretty humorous quotes from all sorts of famous people. There wasn’t really one that captured my attention enough for this topic, but generally the notion that we pretend to live in a “free-market”, that supply and demand are equals on the seesaw of life. We forget the invisible hand, the outside influence of the “greater market interest” that is bestowed upon us at the whim of politics or stock market balance. Today’s topic, INTEREST RATES, is the single largest contributor to influence in our real estate and related markets.
“Hey Steve, how’s the market? What are rates today? Are rates going up? When are rates going down?” It’s all part of being in the business that most conversations include these questions but are they the real questions?
In the ever-evolving landscape of real estate, there is one constant that can make or break a deal, shape market trends, and influence investment decisions: interest rates. The relationship between interest rates and the real estate sector, both commercial and residential, is intricate and profound.
So why is everyone talking about interest rates? At its most simplistic definition, what are Interest rates? Interest rates, typically set by central banks, determine the cost of borrowing money. When rates are low, borrowing is more affordable, leading to increased demand for real estate. Conversely, when rates rise, borrowing becomes more expensive, potentially cooling the market.
Even deeper than that, in today’s environment, when rates rise sharply, lending criteria changes, banks change monetary policy, rates for borrowing and investing start doing odd things and don’t relate to one another like they do in a “normal” economy.
The Residential Market:
Mortgage Rates and Homebuyers' Behavior: Residential real estate is significantly influenced by mortgage rates. When interest rates are low, potential homebuyers can secure mortgages with lower monthly payments or at higher approval amounts, making homeownership more accessible. More buyers with more money stimulate demand and when the supply of homes does not meet demand, this drives up home prices. Sellers who saw this activity over the past few years are now caught short and may have missed the boat that delivered record prices, cash offers and little due diligence.
Refinancing Opportunities: Lower interest rates not only attract new buyers but also entice existing homeowners to refinance their mortgages. This can free up disposable income or allow homeowners to access equity, which can lead to increased consumer spending and investment. These homeowners are now incentivized financially to stay in their homes long term as their cost of a new home represents a significant financial change, psychologically so in the concept of paying a rate double their current rate and also on a larger balance. These sellers and potential buyers are frozen in time in their current homes.
The Effect of Rising Rates: Conversely, rising interest rates can dampen demand in the residential market. Higher mortgage rates increase the monthly cost of homeownership, making it less appealing for some buyers and reducing the demand or number of buyers in the market. This year the real estate market has witnessed an almost instantaneous contraction in the number of buyers in the market. Buyers who once qualified at an entry level price point and a low rate, now can’t qualify with the new higher rates and are frozen out of the market.
So as we now move forward and talk about the current real estate market, we need to be mindful of these “invisible hands” that influence the markets. It’s not always about a seller setting a price right or a buyer crafting the right offer. Our market has a host of anomalies that influence its movement.
With all of those factors, what can you do?
Stay Informed: Keep a close eye on central bank policies, interest rate forecasts and your market metrics to anticipate market shifts. Have days on market recently changed or the number of listings available? Metrics matter as we plan for future moves!
Diversify: Spread investments across different property types and locations to mitigate risk associated with interest rate fluctuations. Look at loan maturity dates, project cash flow needs and prepare for the next year or two as the market stabilizes.
Long-term Perspective: Consider longer-term financing options to lock in lower rates, especially when rates are historically low. Build your war chest and look for investment opportunities as there will be properties that need to sell for various reasons related above. Also, there will likely be less competition for these investments.
Risk Management: Develop contingency plans and stress-test investment strategies to assess their resilience in different interest rate scenarios. A sound financial plan will enable you to make management decisions confidently and keep you from finding yourself short.
The impact of interest rates on residential real estate markets cannot be overstated. These rates serve as a barometer for the health of the economy and play a pivotal role in shaping investment decisions and market dynamics. As stakeholders in the real estate sector, understanding the intricate relationship between interest rates, property values and consumer behavior is crucial for success in an ever-changing landscape. By staying informed and adopting prudent strategies, we can effectively navigate the waves of interest rate fluctuations and thrive in this dynamic industry. Aligning yourself with experienced professionals is even more important than ever, even though the market feels rocky we are still navigating a strong market historically.