Rising Interest Rates Are Good For U.S. Real Estate Investors: Learn How?

Michele Lawrie, CREO - HomeAbroad  by Michele Lawrie
8 min read
Rising interest rates in US

As we know, the Federal Reserve has been gradually raising interest rates since late 2015. This is good news for foreign real estate investors investing in the U.S. market, as it signals a strong economy and increasing confidence in the market. In addition, higher interest rates make investments in real estate more lucrative, as buyers can lock in longer-term loans with attractive interest rates. So if you’re a foreigner looking to invest in U.S. real estate, now is a great time to do so. Keep reading to know more!

Historic and Current Inflation Figures

For the longest time in the last ten years, real estate investors in the United States have not suffered high inflation, enabling them to relish access to cheap capital, due diligence, and underwriting from lenders.

But the recession from a few years ago is still fresh in many people’s minds. However, this has not slowed the current trend of increasing real estate prices. On the contrary, real estate prices have reached levels that we have never seen before.

When the Great Recession occurred, the average mortgage rate went to 6.41%. However, ten years before that (1996), the mortgage rate was 7.81%, and ten years before that (1986), the average mortgage rate was 10.19%.

Currently, the 30-year fixed mortgage rate has not gone up to 5% on an average annual basis since 2009.

A 5% mortgage rate is still incredibly cheap compared to the historical norm. A 30-year mortgage with a fixed rate today is still far less expensive than previous comparisons, as seen in data from mortgage lender Freddie Mac.

At present, we can see the interest rates rising each year. As a result, inflation gets higher than we have faced in the last 40 years.

To fight inflation, central banks use interest rates to control the economy. When the economy is growing too fast, central banks raise interest rates to make it slower. This will also make it more expensive for foreigners to borrow money.

US Annual Inflation Rates
Source: BLS

How can Rising Interest Rates Affect Real Estate Investors?

Generally, home loan rates typically increase, housing becomes less affordable, demand decreases, and housing prices are forced to get lower.

In the current housing market, things are unique. At present, given the economic climate and market, it’s not surprising that contemporary real estate has a distinct flavor from previous eras. The increased cost of housing occurred due to many reasons, depending on:

  • As more and more millennials settle into their 30s, they are approaching the age when they are most likely to buy a home.
  • The effect of COVID-19 has affected the real estate market.
  • Low rates of single-family housing construction due to labor and supply chain constraints

It’s challenging to anticipate how precisely housing will be affected by increasing interest rates because, at the moment, the market trend is somewhere between low and high-interest rates. Still, many experts are confident that foreign real estate investors’ long-term growth will not be affected.

Looking at the current situation, experts suggest that investing in a long-term rental property is the best option as of now meanwhile, any short-term investments can be risker.

Investing in a long-term rental property will benefit you by combating inflation every year. Investing in a home that will make you money for five years or longer is the perfect choice for foreign investors in the U.S.

Reasons Why Rising Interest Rates are Beneficial for Real Estate Investors in the US

Better return on investment

Most major metropolitan areas have a higher rent, which allows investors to get a good return on their investment or make more money from their existing property and improve their Net Operating Income (NOI). Consequently, higher rental prices push multifamily property owners to seek more expensive funding options.

According to Greystone, from June 2017 to 2018, the rent in the United States increased to about 4%. The market was not, however, uniform across all sectors. For example, in New York City, one-bedroom rents dropped 3.1 percent during the same period, while comparable units in Seattle grew by 4.2 percent. Should that aggregate growth persist, buyers shouldn’t be discouraged by existing prices or the prospect of another rate increase in the future.

High occupancy rates mean higher demand in the real estate market.

As of three years ago, the occupancy rates reached 95.8 percent in the third quarter of 2018, even though many new units were added online. In 2018, there were more than 300,000 new market-rate housing units.

Despite an increase in demand, more houses appear to be sold than people who want to buy them. The number of people looking to buy a house is stable enough that the cost of apartments and rental units is rising. This means it is a good time to invest in property because there is more demand than supply.

Value-Add plans are beneficial.

People who want to make money by buying a house and fixing it up are called “value-add investors.” They usually look for houses worth less than other houses in the same area, then try fixing them up, so they are worth more. This can sometimes increase the amount of money they make from the house.

To enhance the operation, we need to reduce the overhead while increasing rents. We can also capitalize on old properties by modernizing them with items such as updated kitchens or bathrooms; this way, we preserve character while adding convenience to the property.

Although commercial property lending rates have increased recently, foreign investors can still acquire affordable funding for improvements.

Tax benefits

Foreign real estate investors in the U.S. may take advantage of the tax code. You can maximize deductions if you surrender a portion of income and capital gains on one side of the equation.

One of real estate investors’ most significant deductions is real property depreciation. Any assets that are not attached to the property, such as appliances or furniture, can be depreciated over a shorter period of time, usually 5-7 years. This can help investors ease the burden of rising interest rates.

3 Things You Must Look Out For When Making Real Estate Investments

Equity and wealth

Investing and being in real estate as a foreigner is a stable and good source of cash flow, and it has been a source of good income for most moguls in the United States. High-Net-Worth individuals in the United States or worldwide invest in real estate in some manner. Real estate is thought to have generated 90% of all millionaires through investments and other real estate practices.

You accrue equity when you pay a property mortgage. As a result, you have the clout to acquire more houses, enhancing your cash flow and wealth even more as you build equity.

Rental yield

Since the rental prices have been rising in most U.S. states, the average rent an American resident pays has increased by 4.8% in the past year, which is higher than the average rate of rising rental prices, according to the government. According to Redfin, the average monthly rent increased to $1,985 — a 6.8% monthly and 20.5% yearly increase. According to Redfin, the median rent in the country reached $2,000 per month.

Cash flow through real estate

You must have probably heard that most foreign real estate investors in the U.S. are used to getting a heavy and continuous cash flow. No doubt that real is estate is the old-fashioned way of “wealth-building technique.” Investments that don’t provide cash flow are few and far between. Consider stocks. For example, you invest and leave your shares alone until you sell them.

When you put resources into acquiring and maintaining real estate, you create monthly cash flow by having tenants pay rent. Your income is the difference between the money received from renting property and the costs incurred. You may use it to cover your expenses, save for a rainy day, or even develop a larger real estate portfolio if your other investments succeed or fail. Passive income is any sort of income that allows you to live regardless of what happens with your other assets.

It’s now or never. If you’re still on the fence about investing in real estate in the United States, speak with a mortgage professional to learn more about your alternatives. Many individuals are unaware that real estate investors make most of their money through cash flow rather than selling property. With cash flow investment, you may generate revenue without having to sell the property, unlike with other investments.

Financial planning comes in handy for future advantages.

A family-owned business may look towards its future generations by involving children or grandchildren in the company. An irrevocable trust, known as an intentionally defective grantor trust (IDGT), transfers property ownership to heirs while still allowing the grantors mentioned above to maintain some control over operations. IDGTs have several advantages, one of which is reducing the grantor’s taxable estate. It also allows successors to gain experience in their desired industry before taking on full responsibility.

What Does Rising Interest Rate Mean for Real Estate Developers?

The position of real estate developers is quite distinctive when it comes to rising interest rates. Real estate developers need to need with two main things in this situation:

  1. Impact on the investment property loan
  2. supply and demand of the consumers

Financing

If interest rates go up, it will become more difficult to finance projects already close to the line. This usually leads to decreased construction as people put off development plans. However, falling material prices could help reduce the cost of housing and real estate.

Supply and demand

A real estate developer must rethink the whole market to fulfill the demand and supply of the consumers. If the Federal Reserve’s increased interest rates have slowed down new home purchases, there are now more renters in the market. Real estate developers concentrating on building apartments or multiple-family homes may see better results, while those who build single-family residences could struggle.

As for investment properties, a build-to-rent development strategy could be more profitable in a market where many people are trying to rent their first home.

Conclusion

The rise in interest rates can be profitable for foreign real estate investors in the United States. When rates go up, it becomes more expensive for investors to borrow money to purchase properties. This often results in a decrease in demand for investment properties, leading to lower prices and fewer opportunities for profits.

Hence, it’s a wise decision to invest in US real estate as a foreign investor because you’ll still be able to make some amazing profits from your property. If you want to buy an investment property in the US as a foreigner, then HomeAbroad can help you connect with the right real estate agent and lender to make your purchase super easy.

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FAQs

Should I invest in real estate when interest rates rise?

The effect on the real estate market can be positive as the mortgage rates rise. The inflation caused in the market of rental properties will lead to fewer rental purchases since not many people will be able to qualify for a mortgage.
Buying or investing during rising interest rates can be a better option because the interest rate hike will cause the prices to reduce for purchase.
An investor’s 1% increase in interest can turn into a windfall of profit in the right housing market. In addition, as mortgage rates go up, people are less likely to buy houses since it will be more difficult to get a loan. Therefore, there is an increased demand for rentals until people can afford to buy a house outright.

Are higher interest rates better for investors?

When interest rates decrease:
Bond prices get high
Chances of potential stock market gains
Lower interest rates on savings accounts
Commodity price rises
Mortgage rate falls
When interest rates are on a hike:
Bond prices lessen
The potential stock market is at a loss
More interest rates on savings account Commodity prices fall
Mortgage rate gets higher
While fluctuations in interest rates may have different impacts on investments, there is no single action you should take when they change. Instead, maintain a laser-like focus on your financial objectives, stick to your plan, and work with your financial advisor to build a balanced portfolio that can withstand any short-term effects of a rate change.

Is real estate a good investment during inflation?

Many foreign real estate investors turn to real estate as a stable investment during inflation. The real estate asset class has proven to be historically stable. In addition, it offers tax benefits, making it an attractive option compared to stock markets.

What happens to mortgages when interest rates rise?

When interest rise, mortgages become more expensive. This makes it less affordable for people to buy a home. When homes are less affordable, the demand for them goes down. This is a result of a slump in the housing market. Sellers then reduce prices to attract buyers.

Michele Lawrie, CREO - HomeAbroad
About the author:
Michele Lawrie is the Chief Real Estate Officer at HomeAbroad and has worked as a real estate professional for the past 15 years, helping domestic and foreign national clients navigate the home buying and selling process.
She is passionate about real estate and strives to educate read more...