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Can A Rising Interest Rate Put A Dent On Real Estate Innovation?

Photo by Grant Lemons on Unsplash

Interest rates across the globe are rising fast as more and more central banks seek to curtail inflation. However, the consequences of this are that debt and borrowing is becoming more expensive and one area where this causes particular problems is in the real estate markets. As both mortgage borrowing and construction financing becomes costlier and harder to secure, we are going to take a closer look at how rising interest rates impact real estate finance. So, let’s take a deep dive and find out what the consequences on real estate innovation in rising rates environment may be.

Real Estate Finance

The most common form of real estate financing is house purchase mortgages; bank loans usually obtained by one or two private citizens in order to buy their home. While there are other forms of mortgage (such as Buy To Let or Commercial mortgages) these ‘Mom and Pop’ transactions form the backbone of the entire retail estate market.

Over the last decade, house prices globally have soared primarily (though not exclusively) fuelled by low interest rates. The unusually low interest rates that have been in place since around 2009 has meant both that mortgages have been historically cheap, and also that savings accounts have been rendered redundant. As such, anybody with money to invest has invested it in bricks and mortar.

The last few years in particular have witnessed something of an asset and real estate which may well be about to burst.

When interest rates begin to climb, mortgage payers are usually the first casualty. Anybody who took out a large (ie, 90%) loan to value mortgage at the height of the pandemic may well now be finding that their monthly mortgage payment is about to double, and that there property is dropping in value. In fact, it seems inevitable that negative equity and a wave of foreclosures/repossessions is brooding somewhere over the horizon.

The knock on effects caused by these ruptures in the housing and mortgage market impacts the entire real estate sector as we shall demonstrate.

Construction Financing

Building houses is not cheap and it is not easy. In order to build, developers need to secure funding and they generally obtain this from banks or equity groups. Construction financing is also considered to be fairly high risk. When lenders advance construction financing funds, they are relying on the developer to successfully complete the project and then sell the houses in order to repay them. If the developer fails then the lender is left to foreclose on a vacant piece of land or a half built shell; the sale value of which is very unlikely to repay even a fraction of the amount owing.

Because of the risk, construction financing interest rates can be high and a rise in interest rates mean that is going to become even more expensive. This may well deter some developers from taking out new loans which in turn means that new houses simply do not get built. Further, any developer who recently acquired new land and obtained lending to commence a new project may soon find themselves running into very real trouble amidst a toxic combo of high monthly payments and collapsing land prices.

Commercial Bridging Loans

Another key link in the real estate financing chain is commercial bridging loans. Bridging loans are temporary, short term loans that act as “bridges” while more preferable, longer term lending is sought. Bridging loans are in many ways easier to obtain than proper financing owing to the increased risk appetites of lenders but the consequence of this is that interest rates are usually very high. Servicing a bridging loan long term is not financially viable and borrowers usually hope to repay them entirely within a matter of months.

Commercial bridging loans are particularly useful in real estate development as they allow developers to acquire land; once they have the land, they can apply for planning permission, and then approach traditional lenders for “proper” financing before breaking ground.

As bridging loans become both more expensive and risky, developers may avoid them meaning that they are less able to acquire new land.

How May Interest Rates Impact On Innovation?

The rising interest rates impact on innovation in real estate is negative and the bottom line is simply that new house building is going to slow down for the foreseeable future. Developers may now be tempted to pause existing projects or simply sit on vacant land rather than risk getting into bad debt. This means that the problematic housing shortage is not going to improve anytime soon and in fact, is only going to get worse as new generations attempt to enter the housing market.

Final Thoughts: Real Estate Innovation in Rising Rates Environment

It is impossible to predict whether interest rates will continue to rise, will remain static or will drop again. Right now, construction financing and all forms of real estate finance are in contraction as both lenders, developers and home buyers prepare for the gathering storm. Mortgage lenders are fast pulling products and commercial bridging loans are also vanishing from the market,

However many commentators seem satisfied that the anomalous days of 0.5 – 1% interest rates are gone forever. Whatever happens, the real estate market will have to adapt, reinvent itself, or else be reinvented at state level. But for now, the future seems disconcertingly uncertain and the fullest effect of interest rates impact on innovation in real estate remains to be seen.

Written by Marcus Richards

Photo by Markus Spiske on Unsplash

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