One of the biggest stories in the financial markets over the last part of 2015 has been the Federal Reserve raising interest rates for the first time in a number of years. This change could have impacts on virtually every type of investment, but some believe that the changes will be felt with particular strength among real estate investments.
A Rise in Mortgage Rates. A rise in baseline interest rates will likely lead to the interest rates on new mortgages, as well as the interest rates applicable to adjustable rate mortgages when it’s time for their next adjustment.
But while the interest rates that are set by the Federal Reserve are certainly tied closely to home mortgage rates, there’s not a direct and immediate 1:1 relationship. In other words, even though we would now expect mortgage rates to begin an upward trend, it’s not clear when the increases will start, and how quickly they’ll rise.
Impacts on Real Estate Affordability. Traditional wisdom would say that rising interest rates exert a negative impact on the price of real estate, at least when it comes to residential properties. That’s because residential buyers generally have a monthly budget in mind when they shop for a new home, and the monthly payment that they’re budgeting for includes both an interest component as well as a principal repayment portion. As interest rates increase, a larger portion of that monthly budget will go to interest, which means that there’s less money available for principal repayment, which means that the total mortgage size will be smaller.
But in many cities around the nation there is strong demand for residential properties (particularly for single family “starter homes” and condominiums). Rising interest rates may reduce the number of interested buyers for a particular home, but there is still likely to be healthy demand for these properties.
Real Estate as an Income-Generating Investment. Real estate can be a great investment for purposes of income generation within your portfolio. Consider single family homes or residential condominiums or similar properties that you may hold in your portfolio. If interest rates rise to the point where those types of properties become less affordable to potential buyers, then those potential buyers are less likely to purchase real estate and more likely to rent their homes.
Greater demand in the rental market will have the effect of driving up rental rates, which will provide a financial benefit to the owners of rental properties. Given that you’re not likely to use financing when you purchase any investment properties with a self-directed IRA (because doing so eliminates many of the tax advantages of your account), rising interest rates could help you generate a larger stream of income with your real estate holdings.
In short, while the Federal Reserve’s decision to raise interest rates might provide some financial challenges, there’s no reason it will negatively impact proper real estate investments within your self-directed IRA.