The economy is booming, and unemployment levels are low, but wage growth has not been keeping pace. The new tax reform is already quelling that problem with its massive cut to the corporate tax rate, and companies have begun increasing wages and offering bonuses. All these changes mean inflation will start to rise soon.
- Rents will grow as wages increase and tenants are willing to pay more
- Interest rates will rise out of historic lows, and asset prices will go down
- The recent boom of price appreciation will slow down with higher interest rates
Rents should rise – As inflation goes up, so too does the cost of living (rents). A thriving middle class is excellent news for the vast majority of landlords. As wages for workers increase, so too do the rents tenants are willing to pay for property. Consumption increases when the flow of money trickles into the hands of the working class. The companies that are offering wage increases and bonus pay are contributing to new affordability of higher rents.
Interest rates will rise – Times have been phenomenal to borrow money. It’s been cheap to acquire loans and deploy capital. That feature of interest rates lends to allowing asset prices (i.e. housing) to reach inflated levels. As the cost of borrowing money goes up, asset prices go down. In the housing crisis of ’08, the Federal Reserve increased its balance sheet to loosen credit (and end a credit crisis) and add liquidity to the market by buying bonds which drove down interest rates. Buying bonds on the Fed’s balance sheet took the balance sheet to a historical level that now has to unwind. This will inevitably remove liquidity from the market and drive interest rates higher. This is uncharted territory and has never been done at these levels. Risk exposure here is unknown and will be delicate. Unknown risks make me cringe when money is on the line.
Appreciation will slow or reverse as interest rates rise – The recent boom of price appreciation we have experienced should slow or possibly reverse in the face of rising interest rates. This is contingent on the pace at which that happens. Multifamily properties could/should see headwinds on asset/property values. If the interest rates on loans move up 50 basis points, investors see a lower debt service coverage ratio (DSCR). That relationship is an important one when seeking financing. The pool of buyers shrinks as the margin of profit decreases. Sellers facing their balloon payment may be forced to refinance at lower price valuations. These are just some of the potential headwinds. They are not guaranteed, but certainly both conceivable and possible.
View the original article at Bigger Pockets