Real Estate Investment in a High-Interest-Rate Environment
Real estate investors are affected by high interest rates despite of whether the real estate investment in private market or public market. The distinction among real estate investment in private market and public market is private market contains investors purchasing real estate property himself whereas public real estate market includes those investors who is purchasing a security in a publicly traded real estate company particularly as real estate investment trusts or REITs.
With exemption of real estate market in 2010, housing prices and interest rates were low similarly interest rates and property values having a converse relationship. For Example, when housing prices are high then interest rates are low whereas when housing prices are low interest rates are high. For private real estate investors or homebuyers who plan on maintaining the property for minimum seven years, it is desirable to purchase real estate property when interest rates are low and values of property are high because property values usually appreciate with time. Additionally, low interest rates with 15 or 30 year fixed mortgage maintain reasonable monthly mortgage payment. Though, for a private real estate investor who can easily afford a large down payment on the property and reimburse the mortgage faster with larger payment, it is worthwhile to purchase property with low property values and high rate of interests. It is because the investors can reinvest the property when rates of interest go down or go for an adjustable-rate-mortgage in which interest rates on the mortgage is lower than market rate.
In REITs, high interest rates are unfavourable to the REIT price, yields and its leverage. As values of property lean to decrease with increasing rates of interest, the REITs price tends to reduce resulting in decreasing dividend payouts and lower the values of REIT generally result in withdrawing investments of investors. Since 2015 , although debt ratio of REITs have kept below 55% for the past 10 years, with the high value of net asset, a REIT can influence more lines of credit or increase more debt to grow. Though, as property values decrease with high interest rates, a REIT’s net asset value also devaluates, in turn devaluating the REIT’s leverage that limits the credit amount it can appreciate.
A yield of REIT’s is directly proportional to an ability of REIT to increase revenue. Revenue is generally accrued from the4 income of rent, funds from operations (FFOs) and related service income. If the REIT grips real estate protected by an extended lease, the REIT should not then increase rents on those properties. On the contrary the inverse also applies i.e. if rest increased on properties in a REIT that now has a lower property value due to high rates of interest. A REIT not only maintains with inflation but also remains profitable devoid of any additional resource consumption when it face the high interest rates market. The high possibility of financial loss faced by REIT with high interest rates in occasionally alleviated with interest rate swaps where the creditor evades the interest rate with swap counterparty. The swap guards the REIT from decreasing in price and permits it to analyse its future leverage.