Hiking interest rate hammers real estate market

[wp_lightbox_prettyPhoto_image link=”http://www.economicsignature.com/wp-content/uploads/2018/02/20180222-IYRvsRate.png” description=”The chart compares the 30-year interest rate with the real estate market (IYR). The two curves show the opposite moving directions, and the interest rate is a crucial signature to the real estate market. Since middle 2016, the interest rate has been inching up from its long-term bottom (as we addressed in Interest rate outlook), so the real estate market does not look promising.” source=”http://www.economicsignature.com/wp-content/uploads/2018/02/20180222-IYRvsRate.png” title=”Hiking interest rate hammers real estate market”]

 

Investing in real estate relies on mortgage, which should be treated as a leverage scheme. Buying a personal home may need a down payment ranging from 5% to 20% of the home price, which means 5x to 20x leverage. Similarly, purchasing investment properties may require a higher percent down payment, but the leverage still can be at least 3x.

Leverage is not free. The mechanism of leverage is that an investor borrows money from a bank and pays interests till paying off the mortgage or till the property is sold. When the interest rate hikes, the investor has to pay more interests when holding the property, leading to a greater cash outflow. If the rent (i.e., the cash inflow) collected from the invested property cannot cover the cash outflow, the investor will incur a loss and will not buy the property.

Let’s look at the chart comparing the 30-year interest rate with the real estate market (IYR). The two curves show the opposite moving directions, and the interest rate is a crucial signature to the real estate market. Since middle 2016, the interest rate has been inching up from its long-term bottom (as we addressed in Interest rate outlook), so the real estate market does not look promising.

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