There are a lot of eyes on the Reserve banks everywhere with the constant talk and gossip of interest rate changes. Truth is, we are going to expect some changes in the coming 12 months as we have had abnormally low-interest rates that aren’t sustainable long-term.
Overnight, the U.S. Federal Reserve increased interest rates by 0.75%.
What does this say from all the gossip?
It’s important to remember that gossip is gossip when it comes to interest rate changes and the people you should listen to are the Central Banks.
Early reports were showing a very possible 100-point rise (1%) in July. Then they changed their mind and were saying last week there is less than a 50% chance of that happening.
Plus, economists were suggesting that it could even be as low as a 15% chance.
Let’s explore what this all means.
Let’s map out the main difference between U.S. and Aus mortgages.
Well, firstly there are several very important differences to note between the U.S. and Australian financial markets. Let me list a few of the major ones here:
- Most U.S. mortgages are what they call Fix Rate Mortgages
Meaning the rate is fixed for the life of the loan (often 20-30 years). While here in Australia, our mortgages are generally variable rates, meaning the rate changes at the whim of the banking institutions.
This is important to note because as a homeowner with a mortgage, as interest rates increase, there is generally no additional financial pressure on the family budget. The mortgage rate is fixed and does not change.
This would only be of relevance if the homeowner was looking to refinance, realising they would need to refinance at a higher rate. As interest rates in the U.S. rise, we do see fewer homeowners looking to refinance until the market settles down.
- Private equity lending
These are loans offered by companies or investors using their funds. They are a massive part of the financial sector in the U.S. In fact, stats have indicated it has just risen to over 50% of all loans taken. Here in Australia, private equity is a tiny piece, with more than 90% of loans, particularly for home buyers, using conventional funds (the big banks).
Again, what this means is that private equity lenders do not follow as strictly, the cash rate of the central banks but often follow the principle of “he who has the gold, makes the rules.” They can set their rates and conditions (within reason) and often can be higher than conventional lending anyway and may not choose to increase rates as they are often not borrowing funds from central banks to lend to their customer base. While they need to be mindful of staying competitive there is certainly more leeway as a private equity lender to set rates.
So, if the rate rises have less impact on homeowners in the U.S., how do the interest rates affect the residential housing market?
Rate rises usually slow the markets down in a couple of ways.
- Fewer buyers out there
- More panic sellers
- Increase in rental demand
As the rates rise, you may see fewer new home buyers shopping around, realising they need to factor in higher interest rates.
While they may have budgeted in a 3-4% interest rate and been able to afford such, now they are looking down the barrel of a 5%+ rate which may stretch them, so back to the drawing board and more savings.
‘Fairweather investors’ often also fall for the doom & gloom reporting from mainstream media and may start to pull out of the market, waiting for the ‘almighty crash’ which inevitably does not come.
Both these factors can then present less demand in the housing market; therefore, properties start to linger longer on market, sellers start to drop prices to sell quicker, and we start to see a drop in median price.
As investors, this is great news. No longer are we lined up with 5 other interested parties when trying to purchase a property and finding that the property sold for above the original list price. Plus, with less demand for properties, particularly if the properties need some work (a Flipper’s bread and butter) we can start negotiating harder on the prices and pick up some much better deals.
Remember too, that these interest rate rises, particularly in the U.S. but here in Australia as well, are not really in play to try and soften the housing market. Both countries (not certain about NZ though) are not concerned with the hot real estate markets, but more about the high inflation rates in the countries.
Rising interest rates have less impact on the household budgets and therefore, unfortunately, less impact on inflation, particularly supply-driven inflation which is what we are seeing here. When inflation is more about the lack of ability of supply chains to match the demand, rather than extraordinary demand for goods and services, increasing rates tend to have less impact.
Supply chains tend to catch up anyway, often just needing time to put infrastructure and labour in place.
Large rises though, as the U.S. has seen, kicks off the mainstream media spreading their FUD (fear, uncertainty, doubt) and it is more often this rhetoric that starts slowing things down as the masses start to believe there is a crash coming. The herd mentality starts to take effect and spending starts to slow. Even homeowners can fall for this, assuming the value of their home will plummet, and therefore attempt to sell before this happens.
This tips more homeowners back into the rental market, along with the new home buyers who start to wait for a ‘correction’ before buying in and increasing the demand for rentals strongly.
As investors, particularly foreign investors, this is again, excellent news. This can bring with it, cheaper labour costs, cheaper materials, certainly purchases and high rental demand for properties. The other benefit is that we do not have to live day-to-day with the impacts of rising rates and high inflation in the U.S., but are still able to take advantage of the benefits of investing.
So, while the media would have us believe the uncertainty, there is quite an ‘aligning of the stars’ when it comes to investing in the U.S. residential market. With cheaper properties, reduction in labour and material costs and still solid demand for properties (either purchase but particularly rentals) it is an ideal time to diversify your portfolio and invest in international markets.
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