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How Do Rising Rates Impact Real Estate Investments?

As economic drivers are slowly pushing interest rates upward, they are having an impact on real estate investment.

The impacts are wide-ranging, and investors could experience fluctuations in vacancy rates, property valuations, and property capitalizations.

Although rates remain historically low, and the incremental changes in rates are not at a debilitating level for most consumers, as interest rates increase over time, property values can become stagnant or even decrease.

This can create a property supply that is greater than the demand for property, which turns the real estate market into a buyer’s market.

With these factors in play, real estate investors should keep in mind the following potential impacts of rising interest rates.

Residential buyers are losing borrowing power.

The rate uncertainty can drive prospective home buyers to rush into homeownership before they are financially stable. When this occurs, unexpected financial challenges down the road (such as job cuts or vehicle repairs) can have a drastic impact on a homeowner’s ability to maintain the property, make mortgage payments, or both. These factors can contribute to potential buyers’ reevaluating the rent-versus-buy scenario.

Although certain property types will be able to withstand increases in interest rates, some investors will be drawn toward the debt market in search of lower-risk opportunities. This means that there will be fewer opportunities for residential buyers to borrow money for home purchases and that the cost of borrowing will increase.

Fewer qualified buyers means higher occupancy rates.

Just because a potential home buyer can’t afford to purchase doesn’t mean they don’t need a place to live. Renting may be the best option available and will often result in greater competition for residential units, especially in larger urban areas. This greater demand can result in higher income per unit and lower vacancy levels. Investors can seize this opportunity to fill rental units, thereby strengthening their real estate portfolios.

This scenario can have a positive impact on capitalization, or cap rates. An increase in rental income without increased expenditures allows an investor to maximize return on investment, or ROI. Increased cash flow also means that an investor can pay down loans faster and free up more capital for additional investments.

Rates may affect the purchasing costs for investors.

Just as borrowing costs would increase for residential buyers, an increase in interest rates can have a detrimental impact on investors, too. On the one hand, property values in an investor’s existing portfolio could be dwindling. No investor wants to be caught in the position of having to sell off property in a down market.

On the other hand, an investor looking to allocate cash flow to a purchase will be required to spend more time and effort qualifying potential opportunities. It would be prudent for investors to create a portfolio that can withstand an increase in interest rates.

Spending time and money qualifying suitable investments that are over-leveraged at this time can strengthen your investment portfolio, thereby lowering the risk of losing money in the long term.