Interest rates are important in the performance of any investment. As rates rise, various investments may respond differently. For example, the stock market may have a negative reaction to rising rates. As interest rates rise, the value of future cash flowing from a particular investment decreases, which results in a reduction in the value of that asset. If you are planning on investing in real estate, or you are already an investor, it’s important for you to understand what an increase in interest rates could mean for your investment.
What Rising Rates Mean for Real Estate Investors
1. Return on Investment: although high-interest rates provide the benefit of increased returns on savings account and act as a boost for banks to lend money and curb inflation, they also have a significant impact on real estate investments. When investors put money into real estate, they do so while expecting a certain return. After all, the goal of every investor is to make a profit. The higher the return on investment intended to be made on a property, the lower the value of such property. This is because the net yield of a stable property is rather fixed, so the sole method to increase the return is to reduce the purchase price.
2. Capitalization Rate: the capitalization rate is a percentage of the purchase price that is returned to the investor every year with the net operating income. When an investor purchased a property, the capitalization rate is calculated by dividing the net operating income by the purchase price. Basically, a high increase in the capitalization rate of any property equally results in a lower price.
3. Interest Rate: when investors borrow money to purchase property, they have to be able to purchase such property at a price that would give them an edge to cover the interest on the loan as well as still making allowing them to make a profit. However, as interest rates continue to rise, investors will have to seek higher rates of return on their property investments. This can only be done by reducing the purchase price on properties that are being acquired by investors.
Effects of Rising Rates on Real Estate Investments
Since rates may continue to increase, which will continually lead to a decrease in property value, investors need to start making wise decisions about their real estate investments. They can start selling while the property value is still high, or they could wait until prices stabilize. Either way, there would always be a change in the market as to how properties are bought and sold.
This generally means that in the situation of a high rise in interest rates, investors would demand a higher return on investments – which always results in making property values decrease. When it comes to investing in real estate, there are several factors that should be considered when deciding whether to purchase an investment property or not, as rate are never fully stabilized. You should always do your homework when looking to purchase a property to ensure that the numbers truly make sense. If you would like to learn more on investing in real estate, I recommend checking out the book The Real Book of Real Estate by Robert Kiyosaki and his advisors.
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