Zain Jaffer is the founder and chairman of Zain Venturesa family office that invests in real estate.
getty
Months ago, sustained price increases in US existing and new homes were supported by three economic factors: declining supply, strong demographic demand and historically low and falling interest rates. At the peak of that surge, homeowners were sitting on more equity than ever, while the buying equation became further out of reach for investors and potential buyers alike.
Now, with a recent spike in interest rates and rapid inflation, the issue of affordability is central. Below is a look at the new factors to consider in the housing outlook and how all of this could affect the market and investors going forward.
10-year Treasury yield spike
The 10-year government bond yield between March 2021 and March 2022 show an increase of 100 basis points. In the world of investing, rising returns typically indicate a hunger for higher risk, higher reward investments in other asset classes, but in the current context it also shows that an aggressive approach by the central bank to reduce inflation.
When experts tracked the average correlation between government bond yields and mortgage rates, they determined a typical spread of about 170 basis points† Using that calculation, the current 30-year mortgage rate would be expected to be around 3.85%, given the current government bond yield of 2.15%, but most rates are currently above 4%† In fact, borrowers are experiencing a higher than normal risk premium, which may be due to the inflation outlook and expected further action from the Federal Reserve.
Obviously, numbers like this will leave investors holding their breath. Rising interest rates are generally net negative for the housing market, as they reduce the ability to borrow and result in less deal flow. Still, real estate remains one of the most stable asset classes, which is why I think it’s important to think of it as a long-term growth strategy. Always remember looking back at previous trends when you’re trying to plan ahead and that adjustments to your portfolio don’t have to be extreme – after all, the market conditions you’re reacting to are temporary.
Downstream Effects
The volatility of food and energy prices complicates inflation calculations. But the remarkable rise in the cost of both raw materials has immediate consequences. With a few representative calculations, investment banking firm UBS expects recent gasoline prices to rise increase a monthly fuel budget by $65† In addition, the United States Department of Agriculture estimates a 3.5% food inflation: Another increased line item on the average budget.
Naturally, investors are holding their breath as interest rates rise. Due to the diminishing ability to borrow and resulting in less deal flow, rising rates are generally a net negative for the housing market as a whole.
In situations like these, I like to try to shift my focus from the market as a whole to specific sectors. While the combination of higher interest rates and higher mortgage interest rates will likely weigh on the housing market as buyers opt for smaller, more affordable homes, it’s important to consider how these restrictions on buyers might affect renters. If fewer potential homeowners are willing to take out mortgages, we may see an increase in people looking for rental properties. If you haven’t paid much attention to the rental market, including short-term rentals, now might be the time to do so.
Industry changes
It is equally important to consider how rising interest rates will change the sector. The numbers are strongly pointing in the red, but I think the real outlook is a little more positive. Nearly 40% of homes in the US have no mortgage. Those homeowners have benefited enough from an increase in equity to allow for a strong purchase, especially if they move into a more affordable market.
While rising rates in comparison to general income figures paint a dull picture, many people in the market segments where prices are booming have much of their wealth coming from equity rather than income. That gives a slightly more optimistic picture of purchasing power than a simple analysis with only monthly income figures.
UBS showed how rising mortgage rates can affect monthly mortgage payments in all market segments. If mortgage rate rises are limited to 50 basis points from today’s levels, the effect could still be manageable, assuming house prices remain roughly the same and limit their rise. And on a better note, some markets that see lower house prices than other market segments still have median incomes comparable to other markets, making the purchase comparison there even more attractive and bodes well for short- to long-term affordability in those areas. .
While investors should keep a close eye on sudden changes (such as inflation), don’t forget the bigger picture. Anyone investing in the long-term potential of the real estate market should ask themselves how attempts to curb, say, climate change, will affect some of the market’s basic principles and practices. Failure to comply with new regulations, such as requirements to decarbonise properties, can have significant costswhile staying ahead of these changes by investing in properties using green technologies can yield significant returns. This is just one example of keeping abreast of changes in the market; I’ve found that the most effective strategy is to maintain a mindset (and a portfolio) that’s as alert to what’s happening now as it is to what’s going to happen in the years to come.
It’s the magic of the market that the invisible checks and balances, with a bit of luck, work together towards market strength and an overall increase in accessibility and affordability. And energy in the economic sense is not created or destroyed; much of the current returns in the housing market have moved to rental space, which has become a viable way to earn a side income. With a better understanding of the factors at play and some emergency maneuvers, we can hope to return to market equilibrium in the next phase of recovery.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice on your specific situation.
gotechbusiness.com Business Council is the leading growth and networking organization for entrepreneurs and leaders. Am I eligible?
