Any economist will be more than happy to tell you that interest rates have a big effect on the value of the income-producing real estate. Shrewd real estate investors will always take interest rates and property value into consideration before adding more properties to their portfolio. It is imperative to point out that interest rates can influence one’s ability to purchase residential and commercial properties. Unfortunately, many people are unaware that mortgage rates are the only interest related factor that has a strong influence property values.
It is also important to point out that interest rates also have a substantial impact on capital flows in the real estate market. What are capital flows? They make up the supply and demand for mandated rates of return on investment. As a direct result, interest rates will move property prices in different ways. This is the primary reason why capital flows are closely monitored by many economists and real estate insiders.
The Fundamentals of Evaluating Real Estate Properties
You must have a clear understanding of the income approach to real estate values. Without this knowledge, it will be extremely challenging for you to know how capital flows, interpret financing rates and know how government controlled interest rates move property values. To be honest, the income approach is the best way to calculate property value. This is the primary reason why it is being taught in real estate schools around the country. The income approach can be compared to the discounted cash flow analysis used in the financial markets around the globe.
In laymen terms, learning how to evaluate real estate properties can help you determine how much income the prospective property will generate throughout the entire year. Your passive income payments can come in the form of lease payments or the occupancy rate if you are dealing with a hotel. You take property costs and the financing cost into consideration. After all the operating expenses are computed, you will be able to figure out the net operating income.
You can get the net cash flow after you subtract capital costs and the investment capital used to maintain the property. It is also vital to mention that non-property expenses must be deducted from the net operating income. In many instances, properties do not have a stated dividend policy. As a result, net cash flow will be equal to cash reserves that are available to investors. You can figure out the actual value of the subject property if you look at the discount the cash flow stream for a particular investment period.
A landmark study done by justinhennessey.com elaborates that interest rates can have a significant effect on the cost of financing and mortgage rates. As a result, property level prices go up and down. In the end, the property value will be influenced. However, we must recognize that supply and demand for capital and competing investments have a bigger impact on required rates of return and property investment values. It is worth mentioning that the activities of the Federal Reserve will also have an effect on the real value of all investments.
Changes in capital flows can determine if more commercial and residential properties will be purchased by investors. The price of capital will determine if the market will move in a progressive or regressive direction. An abundance of capital in the market will prompt investors and prospective home buyers to make their move. In simple terms, investors will pursue more deals if the purchase funds are available and prospective home buyers will buy more homes. The price of capital and capital availability determine property values.
When we look at capitalization rates and the derivation of discount concept, we don’t have any problems in seeing the impact interest rates have on the real estate market. The capitalization rate is considered to be the investor’s dividend rate, and the discount rate is equivalent to an investor’s anticipated return on their money. Here’s the formula: (K-g). The letter g represents the predicted increase in income or the noticeable increase in capital appreciation.
Both rates are dominated by prevailing interest rates. For many investors, the risk-free rate is the rate attached to United States Treasuries. U.S. Treasuries are attractive to conservative investors because the chances of the government failing to repay are pretty low. Investors know that high-risk investments must offer a high return. This minimizes their risk. This is why they don’t hesitate to add a risk premium to the risk-free rate. This simple measure helps them calculate the real risk of taking on a project.
Because K is equivalent to the risk-free rate and risk premium, the capitalization is equivalent to the risk-free rate and risk premium. The anticipated growth (g) in income is wisely deducted. Please keep in mind that supply and demand have a direct relationship with risk premiums, and discount rates will differ because unpredictable interest rates create them.
The Final Word
Investing in real estate is one of the best ways to earn impressive passive income. It is imperative for you to concentrate on mortgage rates because they have a significant impact on property value in the real estate market. A mortgage calculator can help you research interest rates with ease. Experienced real estate investors and smart home shoppers use a mortgage calculator before making their offer.
Fluctuating interest rates influence many aspects of real estate. Besides determining the market price of your home, interest rates also determine how much capital is available for investment deals. As I mentioned earlier, capital flows will always influence the supply and demand for prime property and property prices. It is also worth mentioning that substitute investments are affected by interest rates.
The changes related to the rates of return for residential and commercial real estate will not stay the same during periods of destabilization in the credit market. The future of the market is unclear and unpredictable at this moment. It is fair to say that experienced real estate investors will always take measures that will help them limit their risk while pursuing exceptional real estate properties. You should do the same.