Investors contemplating investing in real estate will need to decide if an improving US economy outweighs any potential temporary negative effects of a hike in interest rates. While the Federal Reserve was almost certain to raise interest rates this summer, the Greek debt crisis and the melt down of the Chinese stock market brought the wisdom of that decision into question.
Even in light of those circumstances, Federal Reserve Board Chair Janet Yellen testified in front of the House Financial Services Committee: “If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target.” This statement came out in mid-July. Yellen went on to say this is based on the U.S. economy continuing to strengthen and the employment picture continuing to improve. This is further supported by the recently released statistics that the unemployment rate remains at 5.3 percent.
PENSCO Trust Company's View of an Interest Rate Hike
PENSCO Trust Company is a regulated, self-directed IRA custodian that helps investors use their retirement account funds to invest in real estate, private equity and other non-exchange traded assets. Here is Mike Howe's (director of institutional products at PENSCO) take on what an interest rate hike could mean to real estate investors:
- REITs: According to conventional wisdom, rising interest rates are bad for REITs. The theory is that investors hold REITS because of their high dividend income, and REIT dividends become less attractive as bond yields rise. However, historical evidence hasn’t always supported this theory. Forbes examined what happened the last time the Fed raised rates and found that, contrary to expectations, REIT stocks outperformed the overall market. During the two-year period when rates were rising, REITs returned over 60 percent – far above the S&P 500’s return of 20 percent. The reason for the exceptional REIT performance was that interest rates rose along with a strengthening economy. As demand for rental units grew, so did rents and property values.
- The current situation appears similar in that Fed rate hikes will be tied to the strength of the economy. Forbes said an improving economy could bode well for office, retail, and housing REITs, which benefit from employment growth and higher consumer spending. Healthcare REITs could also do well; healthcare remains one of the fastest growing sectors of the US economy. Increased demand for commercial real estate could also push REIT cash flows and valuations higher since the supply of properties remains constrained by a slow pace of construction activity, Forbes said.
- Investment properties: For PENSCO clients interested in owning rental properties in their self-directed IRAs, rising mortgage rates may increase the costs of purchasing properties. On the flip side, an improving economy means property owners could benefit from higher occupancy rates and rents, which increase the value of real estate. Investors currently contemplating the purchase of a rental property should carefully weigh whether the anticipated income stream from monthly rents will be sufficient to offset mortgage, maintenance, and other expenses.
- Leveraged property investments: Higher lending rates usually mean lower cash returns for investors who use leverage to purchase properties. However, if rate hikes come with an improving economy, demand for commercial properties could rise, resulting in higher rents and richer valuations for properties.
Owning real estate in your IRA can offer portfolio benefits such as diversification, and it can act as a hedge against inflation. But investors who are contemplating using their IRA to invest in real estate will need to decide if an improving US economy outweighs any potential temporary negative effects of a hike in interest rates.
Photo Compliments of Pensco Trust Company
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.
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