Record-low interest rates are in the rear-view mirror. Interest rates fell after the Great Recession, stayed low through the Brexit surprise of 2016, then plunged to new lows during the coronavirus pandemic. But that trend reversed in 2022, as the Federal Reserve began raising rates aggressively.

The era of super-cheap money might be closing, but that doesn’t mean you shouldn’t invest in rental properties. In fact, investing in rental properties remains a compelling opportunity, one that can produce positive cash flow and long-term appreciation.

What’s happening with interest rates?

Interest rates are rising sharply. The Federal Reserve boosted the rate it controls by three-quarters of a percentage point at its June 2022 meeting, then again at its July 2022 meeting. The highest inflation in four decades has forced the Fed’s hand – the central bank has been raising rates as a response to runaway price hikes.

The Fed doesn’t directly control mortgage rates, but it does set the general tone for borrowing costs for real estate investors. Reflecting the changing rate environment, average rates on 30-year home loans soared from less than 3 percent in 2021 to nearly 6 percent in June 2022.

What does this mean for real estate investors? 

The effects for real estate investors are mixed. If you’ve locked in a fixed rate for a long-term mortgage, this latest spike won’t affect your bottom line. If you have a variable-rate loan, on the other hand, or if you have a balloon payment coming up, your borrowing costs will rise. And if you’re applying for new financing to acquire a rental property, your rate will be a full 2 percentage points higher than it might have been in 2021. The tougher rate environment means investors should research a variety of options, including interest-only loans and debt-service coverage ratio mortgages.

Affordability squeeze keeps renters from buying

Since the coronavirus pandemic, property prices have soared. The median home price in the U.S. rose to a record $416,000 in June 2022, according to the National Association of Realtors. The combination of rising home values and soaring mortgage rates have created an affordability squeeze. Many renters who would like to buy homes find they simply can’t afford to do so. This trend is unfortunate for those who can’t buy – but it’s an opportunity for multifamily investors. It means real estate investors have a plentiful pool of creditworthy tenants.

Real estate acts as a hedge against inflation

Inflation has risen to its highest levels since the early 1980s. In June 2022, the official rate of inflation in the U.S. surged to 9.1%. Real estate is considered a reliable hedge against inflation. In a period of rising prices, owners can command higher rents when negotiating leases, and they can get higher prices when it’s time to sell. But inflationary periods typically correspond with higher interest rates for mortgages, a reality that increases an investor’s cost of borrowing. 

Inflation pushes rental rates higher. Owners typically can pass through rent increases to tenants. In an economy where business costs of all sorts are rising, tenants all but expect higher bumps in annual rents. This is especially true if the inflationary cycle is being driven by burgeoning demand and a booming economy. If, however, rising prices are spurred by a jump in the underlying cost of goods, real estate investors might not have as much leverage to negotiate higher rents.

Because of its reputation as a hedge against inflation, real estate becomes more attractive during periods of rising prices. Investors don’t want their money to lose value by sitting in cash, so they look for places to park their cash that will generate inflation-beating returns. In this self-perpetuating cycle, more money chases properties than there are properties available to buy, and prices move higher. Inflation creates a common-sense reason for property prices to rise: If building materials cost more today than they did a year ago, the replacement value of any existing building is climbing. This is another reason inflationary conditions push property prices higher.

Final Thoughts

Rising interest rates pose a challenge for real estate investors – they increase your borrowing costs and cut into your bottom line. However, the interest rate spike of 2022 creates opportunities, as well.