Real estate mortgage interest rates have bottomed out several times since 2008 as a Federal Reserve tool to prop up a shaky economy. Lowering interest rates can be controlled to a degree by the Fed and provide for higher cash flow for real estate investments as less of the income is used to service loan debt. The Federal Reserve Discount Rate has been zero since 2009 which has proved to be an effective tool for economic recovery, but also leaves the FED without any further control against a shaky economy because you can’t lower that rate less than zero.
Now that there is some substance to the real estate investment market, the FED has increased this rate in quarter point increases over the last two years. The Discount Rate is now at 2.25%, up from zero, and will be at 3% by the end of 2018. This slow methodical rate increase does two things. First, it gives the FED something to lower in the event there is an economic downturn. Second, it slowly raises the mortgage rates that investors pay for loans. At the bottom of the curve, the commercial property mortgage rate was at 3.25% and it is now hovering at just under 5%. By the end of 2018, this rate should be at 5.5%.
The market will respond to this rate increase. The cost of ownership goes up so profits go down. Landlords will slowly raise rents to reflect this additional cost, profits will again rise and the cost and hopefully the value of these investment properties will increase. This value increase will maintain the investor equity thus protecting them from this inflationary trend. As in past inflation cycles, it is very likely that owning real estate as well as other hard assets like gold and silver, will actually profit the investor at a greater rate than the erosion of equity caused by inflation.
No, I am not an economist, but after watching commercial real estate markets for 41 years, I am a keen observer of this phenomenon and welcome it for real estate investors. This increase in property value due to inflation is also magnified by the leverage a mortgage loan provides investors. If the property inflates in value by 5%, and if an investor has a 75% loan on the property, the equity increase for the investor is actually 20% due to having only a 25% cash investment in the property.
Moral?: Buy leased investment real estate to not only maintain the value of your dollars, but to also realize an arbitrage due to the nature of a leveraged investment!
Jeff Edberg, CCIM, SIOR is a real estate Broker Associate with Lepic-Kroeger, Realtors in Iowa City, Iowa and has been practicing professional commercial real estate sales for 41 years.