Fed Rate Hikes: The Essential Guide For Property Investors

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December 18, 2015
Tranio

America’s central banking system, the Federal Reserve, has finally increased the interest rate to 0.5% after nine years at 0.25%. They also confirmed more to come, possibly even 3.5% by 2018 if the economy holds firm — and that’s not it. The UK has also been preparing to raise its interest rate up from 0.5% around mid-2016 if it can control its fluctuating inflation.

America’s interest rate hike will surely be the first of many

Key points

– higher interest rates reduce property value
– low-yield property earns more over long-term
– real estate prices rise faster than inflation
– diversified investment portfolios are most profitable

Fed Rate Hike Effect on Real Estate

Higher interest usually leads to reduced asset value, particularly in real estate, so foreign investors should be concerned, now that global instability is pushing capital onto these safer markets where interest is growing. Surviving the market correction is not rocket science, but it does require expert knowledge and some skill. So as the world gets ready to put their post-crisis “easy money” policies to rest, here’s what you need to know if you want to maintain and maximise your profits.

The end of “easy money”

Economic theory and practice show that expensive credit slows spending, and there is a lot of money being spent on the world’s leading commercial property markets at the moment, like in New York, where furious competition between locals and Chinese investors ignited price growth and supply dwindles. Access to cheap loans has created an artificial market boost and encouraged speculation on markets with fast price growth.

Property or stocks: choose your country

But even though real estate prices are probably going to hit their sticking point, it’s not everywhere or even for the long haul! In fact, over the last twenty-four years in the EU and the last twenty years in the UK, real estate value has grown faster than the stock market’s and inflation, showing property itself to be most reliable investment vehicle.

However, stocks have shown themselves to be a better investment vehicle over the short-term in the United States and Europe: America’s S&P 500 and MSCI World Index have both risen over the year following the last five interest hikes according to The Economist. This is why it’s important to split investment portfolio risks between different vehicles and different countries.

Property price growth beats inflation

When the interest rate rises, asset prices usually fall and this is what real estate experts are expecting over the next five years, but it doesn’t mean you should stay away from commercial property. On the contrary, property protects capital against inflation, both in the US and the UK, top destinations for foreign property investments amid global uncertainty.

Buying in reliable markets that benefit from the rule of law and stable currencies is the best way to protect capital from currency swings as witnessed in China and Russia this year.

Capital value grows faster than rent everywhere

Location is a key indicator of liquidity for property and in good times as in bad, there are places investors should not stray. Oftenhigh yields are bate for buyers who consider immediate earnings rather than looking at the long-term picture, leading away from the city centres and into the sticks and suburbs. But in commercial real estate, capital value grows faster than rentover a ten-year period.

In fact, during Q3 2015 alone, office rent values only grew 0.8% but capital values gained 2.6% according CBRE’s Global Rent and Capital Value Indices.

So even though it might be ‘love at first’ with high yields, save marriage for solid segments (like offices and retail) in city centres because they have stable demand and more value at the end of the day.

Diversify your portfolio like a pro

So there’s no one answer, which is why investing requires a bit of mental gymnastics, but hopefully by now, it’s clear that:

property value grows faster than inflation, protecting your capital
balance short and long-term profits with property and stocks
choose low-yield but well-located property for better profits

To balance long and short term earnings, diversify your portfolio into real estate, stocks and cash. Rising interest rates in the UK, Europe or the States should no longer be a worry and it’s important to remember that higher interest is a positive sign! It shows that the economy is doing well, which is what everybody wants, right?

The ideal investment (yes, there actually is one)

Before getting into specifics, I honestly can’t underline how important liquidity is! It essentially determines how easily you cansell your investment in good times and bad but also limits the risk of having to drop the price if you need a quick exit strategy. Simply put, it’s always in demand and you know what they say: “the lower the risk, the less you lose.”

Location: districts in major city centres
Interest on loan: fixed rate, 2%
Yield: 5% is the best option but hard to find
Property type: retail or retirement home
Budget: $5–10 million
Loan-To-Value (LTV): 60%
Lease contract: 15–20 years fixed term
Limit risk: diversify to stocks and bonds for higher short-term yields

This is how investors survive market corrections after interest rate hikes — because this isn’t the first, nor will it be the last.

What about first-time home buyers?

And if you want to buy a new home for your own personal use, ignore the hype about interest rates, avoid the variable interest option on your mortgage and only buy when you have the money (e.g., your LTV is not too high). Oh, and by the way, the standard variable interest rate on mortgages is now the same as the fixed rate.

Retail and office property in central locations are a safe investment bet

Conclusion

It may have been “the worst financial crisis since the Great Depression” according to the Federal Reserve’s Chair, Janet Yellen, but now it’s time to put a stop to monetary experimentation and get back to where we were before 2007 — just with better credit controls, diligent due diligence and solid profits. Bigger hikes are on their way in the next five years. Property won’t escape the readjustment, neither will investors who put their money before their research — but it doesn’t have to. It’s possible tosurvive and thrive during market corrections, it’s just a question of common sense and a little help from the experts.

George Kachmazov, managing partner at Tranio

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Gerald and Genevieve
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