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How Interest Rates Effect Real Estate Investments?

How Interest Rates Effect Real Estate Investments?

There might be more than one instance when you must have come across an expert advice on how it is the right time to buy property as the interest rates are an all time low or how you should wait for the interest rates to stabilize to invest in a new property. But, how does the movement of interest rates really affect the real estate market? This post is a perusal of the same.

There are multiple factors that affect the property market of a particular place. While demand and supply dynamics have the most profound effect, the demographics, the economy, government policies/subsidies and last but not the very least, the interest rates also play their role in driving a location-specific real estate market. Out of these, the least understood or, the most misunderstood factor is the interest rates. While experts continue their rant on how the rise and fall of interest rates is going to affect property market’s valuation, most of us continue to remain oblivious of the effects and causes of this phenomenon. The simple truth is that interest rates and its flow greatly influence a person’s ability to purchase a residential property.

The effect on mortgage rates

The biggest interest –related factor that influences property values is mortgage rates. A rise or fall in interest rates has a direct impact on the cost of financing and mortgage rates, which in turn affects the real estate values and related investments. When the government-influenced interest rates fall, the cost to obtain mortgage or a loan decreases, creating a higher consumption and demand for real estate. This growth in demand pushes the prices upwards. Similarly whenever there is a rise in interest rates, the financing costs increases, thus lowering the effective consumption and prices of real estate.

The effect on capital flows

When the interest rates are low, the cost of living, investing or doing a business is also low. This makes loans more affordable and more people are willing to spend money, leading to ready availability of funds and stimulation of economy. Similarly, when rates rise, there are fewer funds available for investment. The amount of capital affects the demand and supply dynamics of the property.

The effect on Real Estate Investment Trusts or RIETs

Real estate investment trusts are companies that own and operate income-producing real estate. The REITs have in their portfolio commercial properties of many types such as office, warehouses, apartment houses, hospitals, shopping complexes and hotels. There are three types of RIETs, namely, equity, mortgage and hybrid. Out of the three, equity is the most common.

The impact of interest rates on RIETs is a little different to that on residential real estate. In many ways, it resembles the relationship of bond with interest rates. The bond prices and interest rates are inversely related. As one rises the other falls. Similarly, when there is a fall in interest rates, RIETS’ high yield attracts consumers and their value climbs up. On the other hand, a rise in interest rates makes RIETs a less attractive proposition for investors and therefore, their value stoops down.

Most real estate investors or end buyers focus on mortgage rates as they have a direct impact on the real estate prices. However, since interest rates are a macro-economic factor, its effects on capital flow and demand-supply dynamics results in the fluctuation of property prices, which in turn affects the quantum of real estate investments.

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