The Impact of Trump & Higher Interest Rates on Real Estate Investing
The election of Donald Trump as President raises a myriad of questions. One question many investors are asking is “What will be the impact on real estate?” I won’t speak to real estate as a whole, but I can share our perspective as to the potential effects the election will have on OpenPath’s investments in large multi-family apartments.
For most of 2016, many financial analysts have expected interest rates to rise. For various reasons they did not. Now that the election is over, regardless of the winner, most fully expect the Fed will finally raise the benchmark rate in December. Trump’s win and stated economic agenda serve to increase the chance of higher rates in both in the short-term and potentially in the years ahead. So the real question is what effect will rising interest rates have on OpenPath real estate investments.
The net-net: in the face Trump’s election win and potentially rising interest rates we expect our existing properties to continue to meet — and possibly even exceed expectations. Further we see plenty of opportunities for new investment and expect that OpenPath’s unique model can continue perform in an environment of rising rates. This will require that we continue to be highly disciplined in our buying decisions and conservative in how we model our projections.
To dig a little deeper into the impact of a Trump presidency and rising interest rates on OpenPath real estate it will be helpful to look at the three key drivers of financial performance at our properties. These are occupancy rates, operating income, and expenses.
One of the cornerstones of our model is to identify secondary real estate markets that are experiencing steady economic growth and then to go deeper into the sub-markets to find opportunities where workforce housing is constrained. This leads to high occupancy rates at our properties. We don’t see anything that a Trump presidency will do to change this situation in either direction.
The biggest expense at all of our properties is our mortgage. Higher interest rates mean higher expenses. The good news is that OpenPath’s standard approach to acquiring new properties is to secure long-term fixed rate loans. (i.e Lake Tonopah, Aspen Meadows, Cheyenne Crest, Reflections at Highpoint all have fixed 10-year loans). So rising rates really have little to no effect on the expenses at these properties. Furthermore, as interest rates rise, our low fixed rate loans make our existing properties more attractive to potential buyers given that these loans are transferable to a new owner. This enhances the value of our properties. With regards to future acquisitions, higher rates will require us to stay disciplined to ensure that we don’t overpay for these new properties and that our income models (rent projections) will support any higher costs.
This leads to the last key component in financial performance: income. Typically interest rates rise when the economy is improving. This is certainly what has been happening in the US for many years now, albeit more slowly than many have hoped. Trump’s plans for fiscal stimulus should improve the economy further. Higher employment rates and rising wages, in turn, result in higher prices for goods and services — and that includes housing. So the good news is that along with rising interest rates and an improving economy we should also see higher rents. For OpenPath’s existing properties an acceleration in the rise of rents coupled with our low fixed cost loans could mean we possibly even see operating performance and financial results exceed our expectations. Regarding new properties, where rates and our costs may be higher, we will need to ensure that rents are in fact rising in a way that makes sense and works in our financial models. Again, we see plenty of opportunities ahead and will continue to be ever-disciplined on our buying decisions as conditions change.
While rising interest rates may make investing in multifamily real estate more challenging, it is also important to consider the impact higher rates may have on other investor options particularly stocks and bonds. The stock market continues to trade near all-time highs as the current bull market is about to extend into its 9th year. How long can this continue? What effect will rising interest rates have on the stock market? Rising interest rates historically are not good for equities as they constrain consumer spending and corporate investment. Conversely, higher rates can be a good thing for buyers of new bonds. (Existing bonds will be negatively impacted). But it’s important to look at this in context. Over the last many years, bond yields have declined to record lows. The returns are many bond issues are almost zero. Interest rates would need to climb significantly for a number of years before returns on new issues become remotely attractive. (Note: In the last 8 years the Fed has raised its target rate just 0.25%). How does OpenPath compare to stocks and bonds? Going forward, we expect that new OpenPath opportunities will deliver a preferred annual return in the ~6–8% range and ~14–15% IRR. These are broad projections and subject to change based on the information we have at the time of investment. We will provide more details on projections of specific opportunities/properties as these come available.
In conclusion, if interest rates begin to rise we do not expect to see any material negative effects on our existing OpenPath investments. Going forward, higher rates can make OpenPath real estate investing more challenging but we continue to see opportunity for our model to deliver on our projections and provide market-beating returns.
As always, let me know if you have questions or would like to discuss. You can reach me at David at OpenPathInvestments.com
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