Saturday, 6 May 2017

Michael Bach Atlanta | How Will Emerging Markets Real Estate Respond To A Rising US Interest Rate Environment?

Following the cataclysmic disruptions triggered by the subprime crisis, real estate markets in the US, and other major economies across the world were left in a tailspin. A prolonged economic slowdown and contracting job markets resulted in a flattening of real estate prices in major cities globally. As seen in the graph below, price movement over the past ten years has been somewhat uninspiring in some cases across North America, Europe and Asia.

Due to an extended low interest rate environment, real estate in the US and other parts of the developed world have showcased signs of recovery in recent years. However, with the recent federal rate hike in the US, the path to recovery may not be without jolts. With frequent rate hikes in the US expected in the coming quarters, the mortgage rate could be up to 5.5% by 2018 — a significant rise from the present value of 4.2% (30-year fixed).

A surge in mortgage rates will translate into a higher equated monthly installment (EMI), and hence not a very healthy sign for a recovering real estate industry. It will also increase the cost of capital for developers, which could impact the momentum of new projects.

A surge in rates will also be inimical to REITs and their borrowing bandwidth. As rates climb it could also render REITs and other dividend driven instruments less attractive, with capital potentially being reallocated to the bond market in search of better returns.

Given the fact that US federal rates are believed to be one of the most significant benchmarks in the global economic environment, the ramifications may soon be felt in other developed economies as well. The central banks of the UK, Australia, and Canada all could follow suit with rate increases in the near future.

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