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How Will Higher Interest Rates Impact Real Estate?

How Will Higher Interest Rates Impact Real Estate?

How Will Higher Interest Rates Impact Real Estate?

With inflation reaching forty-year highs the Federal Reserve (Fed) has started increasing the federal funds rate as part of an attempt to control  inflation.  As interest rates rise that does affect the cost of things like mortgages (both residential and commercial), credit card rates, auto loan rates and more.  The thought process is that higher rates will soak up some of the excess money that is out there which is causing inflation to go up.  This article looks at how buyers of commercial and residential real estate will be impacted by higher interest rates.

Homeowner

When it comes to the individual homeowner with a fixed 30-year mortgage they will not see any difference in the payment of the principal and interest portion of the payment since their interest rate is fixed for the entire term of the loan.  The mortgage payment can change with a 30 year fixed interest rate mortgage through taxes and/or insurance going up.  If the homeowner decides to refinance their mortgage they could see an increase in the amount of their mortgage payment if the new interest rate is higher than the old interest rate or they also take some cash out the home’s payment reminderequity thus increasing the loan amount.  In the US adjustable-rate mortgages (ARM) for homes are not very common as compared to the past where more home buyers had the option of buying a home with an ARM.

If a homeowner has a Home Equity Line of Credit (HELOC) usually the interest rate is variable in those types of loans.  With a HELOC the homeowner has a line of credit which they can borrow from if they want to.  The money they borrow is usually subject to variable interest rates.  Therefore if a homeowner already has money taken out of their HELOC and the interest rates rise their payments will also rise as the lender will adjust the interest rate of the HELOC upward (or even downward if rates are going down).  Home Equity Loans usually have fixed interest rates but the money is immediately given to the homeowner upon them closing on the loan versus the HELOC where the homeowner has the option of taking some or all of the available amount now or in the future.

Homeowners will definitely notice an increase in interest rates with credit card debt.  Credit cards usually have variable interest rates.  Not only do credit cards have variable interest rates they also happen to have some of the highest interest rates around and therefore is not a good way to borrow money.  When interest rates go up so will the credit card interest rates.  Those with decent or better credit scores and who have a good history of on time payments can request that the credit card company the monthly interest rate.  Any amount of reduction is better than nothing since that means paying less interest overall to the credit card company.  The best approach would be to not carry balances at all on credit cards so one does not have to pay any interest to the credit card company.  By keeping a balance on a credit card month after month and with the amount of interest credit card companies charge it is very hard to get ahead of that so it is best to not do it or get rid of that debt as soon as possible.  

Commercial Real Estate

By the very nature of commercial mortgages their interest rates are variable.  There can be small periods of fixed interest rates but after a certain amount of time the interest rate will be able to float.  Therefore rising interest rates will have an impact on commercial real estate.  How much those rates adjust and how often will be spelled out in the terms of the commercial mortgage.  As a result it is important to read all the terms of the commercial mortgage to know when possible interest rates adjustments can happen, how often the adjustments can be made and how much increase is possible.  

Commercial real estate investors buy properties based on the rents, current interest rate and expenses associated with owning the building.  Changes in the interest rate can have a major impact on whether a particular piece of commercial real estate makes sense for investing in.  In an increasing interest rate environment owners should be accounting for rate increases in the future as part of the decision making process for buying commercial investment real estate.  

Commercial real estate loans also have shorter terms as compared to residential real estate which can have up to 30 years to pay back a mortgage.  The maximum terms commercial investors will see are in the 20-25 year range and more likely to be shorter than that.  If on a very short term or the commercial mortgage has a short period where the interest rate will not change refinancing may be in order if the owner wants to keep the building.  During refinancing higher interest rates will be a factor along with additional closing costs for the new loan.

Renters – both commercial and residential

Interest rates don’t necessarily directly impact commercial or residential renters.  As the cost of credit goes up though those increases will find their way into the rents paid.  Some commercial tenants with long term leases will be less likely to see that increase until renewal time.  Residential tenants on thebucket of coins other hand with their short-term leases can see rents go up much sooner due to increasing interest rates.   Some commercial leases do contain provisions that can cause the rent rate to increase based on the Consumer Price Index (CPI) which is a measure of the rate of inflation.  So while not directly tied to interest rates the rent can go up based on the CPI and in order to control inflation the Fed uses higher rates to bring the CPI down.

Final Thoughts

In order to tame inflation higher interest rates will be needed and the increase has already started.  Increases in interest rates will work their way into the real estate market.  Homeowners and commercial real estate investors need to pay attention to whether interest rates will have an impact on them.

Additional Resources

About the author: The above article “How Will Higher Interest Rates Impact Real Estate?” was provided by Luxury Real Estate Specialist Paul Sian. Paul can be reached at paul@CinciNKYRealEstate.com or by phone at 513-560-8002. If you’re thinking of selling or buying your investment or commercial business property I would love to share my marketing knowledge and expertise to help you.  Contact me today!

I work in the following Greater Cincinnati, OH and Northern KY areas: Alexandria, Amberly, Amelia, Anderson Township, Cincinnati, Batavia, Blue Ash, Covington, Edgewood, Florence, Fort Mitchell, Fort Thomas, Hebron, Hyde Park, Indian Hill, Kenwood, Madeira, Mariemont, Milford, Montgomery, Mt. Washington, Newport, Newtown, Norwood, Taylor Mill, Terrace Park, Union Township, and Villa Hills.

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Discussion

#1 By Gabe Sanders at 5/14/2022 8:47 AM

I think we're already seeing the beginnings of a market change here in my area of Florida. Inventory is creeping up and DOM (Days on Market) is also increasing.

#2 By Paul at 5/14/2022 -1:54 PM

Gabe,
Thanks for the comment. Seeing some of the same here in Greater Cincinnati area as well.

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