How do rising interest rates affect real estate and what will they mean for property investors

As interest rates rise, assets across the financial landscape including real estate are affected. The property sector is particularly synchronized with changing rates. Many mortgage products are designed to track the Bank of England’s (BoE) decisions.

Also, many pundits believe that having near-zero rates for years contributed to the skyrocketing property prices we’ve seen in recent times. In prior decades, the base rate sat much higher than what modern investors are used to.

For much of the 1980s, for example, interest rates hovered above or close to 10%. Throughout the 90s, they fluctuated between 5% and 7%. Yet, in the 21st Century, the base rate gradually fell.

In 2007, the official BoE base rate was around 5%. Then came the global financial crisis. By March 2009, it had been slashed to 0.5%, where it stayed until August 2016.

The EU referendum in June 2016, and the pro-Brexit outcome, prompted the BoE to cut rates further to 0.25%. While they were starting to creep up again throughout 2018 and 2019, the emergence of Covid-19 brought interest rates crashing down to a historic low of 0.1% in March 2020.

However, as the UK emerged from the pandemic and relative normality returned, the BoE slowly started to push the base rate upwards again. The question of how quickly rates should be raised came to the forefront as a new cost of living crisis emerged. Mainly driven by the fallout of the invasion of Ukraine, energy bills jumped which in-turn placed the BoE under pressure to act.

Many young workers and families have known nothing but rock bottom rates. As they creep up, investors and buyers alike will need to prepare for how the wider market adapts.

Source: Bank of England, i news

How do rising interest rates affect real estate and its various components?

The question of how do rising interest rates affect real estate can be tricky to answer. This is because real estate as a concept is made up of multiple elements. Property investors may initially concern themselves with prices, but there are many other areas to consider.

Property prices

Since at least the 1970s, as interest rates gradually fell, average house prices rose. While changing rates undoubtedly have an impact on prices, it should be remembered they’re not the sole element at play. Prices are also affected by supply and demand, changing tastes, shifting income levels, and various other economic factors.

Nevertheless, the BoE itself noted that as interest rates drop, the affect on house prices is self-evident. A working paper from the central bank found that nearly all of the rise in average house prices relative to incomes between 1985 and 2018 can be seen as a result of “a sustained, dramatic, and consistently unexpected, decline in real interest rates.” Where rates rise, and costs increase across the board, we could see a reverse of this trend.

Mortgages

Mortgages are another key part of the real estate world that are affected by interest rate hikes. There are around 2 million people in the UK on variable rate mortgages, just over a fifth of all mortgage holders. Owners of these mortgages will likely see their costs rise in tandem with interest rate increases. Additionally, around 850,000 of these people are on tracker deals, meaning they track the base rate directly and will see an immediate change following a hike.

Rising rates may also lead to new mortgage deals becoming more expensive. This could affect those who are coming to the end of a fixed deal and need to remortgage.

Landlords and the buy-to-let market

So, we’ve looked at how hikes hit buyers and homeowners, but how do rising interest rates affect real estate for landlords? Unfortunately, they may also take hit. Rental yields could diminish as higher interest rates eat into cashflows. Some of these costs may be passed onto tenants in the form of higher rents. But, tenants themselves may also struggle with higher rates and as such, finding renters who can afford raised rents at all may prove to be challenging.

Commercial landlords also face a bit of a mixed bag. According to analysis from Schroders, some sectors may prove resilient in the face of rising rates. Bulky goods retail parks; high quality, energy efficient, city centre offices; and multi-let industrial estates could remain steadfast as costs rise. On the other hand, shopping centres, dedicated conference hotels and offices may be more vulnerable.

What could be on the horizon?

In looking at how do rising interest rates affect real estate, we can see they generally make things more expensive. This may hamper demand among buyers. But, where slowdowns do occur, they’re likely to be short-term in nature. The British economy has faced multiple recessions, rate hikes, and various crises over the years. Yet, demand in the property market marched upwards throughout the decades. Prices reached multiple all-time highs, renters chased ever-dwindling supplies, and sales remained consistent.

Indeed, many commentators have mused on whether the UK will experience difficult years akin to what was seen in the 1970s again. With rising rates, inflation, and labour tensions, it’s understandable that some would make the comparison. But, Schroders also said the UK investment market is much more international, transparent and diversified now when compared to the 70s. It notes: “History may rhyme, but it shouldn’t exactly repeat”.

Property investors may even be able to benefit from rising rates. An expected rate hike could trigger a rush in demand, pushing prices higher, at least in the short term. Eagle-eyed investors could take advantage of this by fixing a property up, and flip it for a (relatively) quick profit.

Generally, interest rate hikes will raise costs for homeowners, if by only a few extra pounds a month. The problem lies where multiple bills come together. Ultimately, most financial products will, in some way, be linked to key economic indicators like interest rates. As such, investors and brokers will need to keep a careful eye on how lenders adapt their products in light of BoE changes.

Source: The Telegraph, Property Industry Eye, Yahoo Finance UK,  AWH Solicitors, The Guardian, Financial Reporter, Schroders