Interest rates are critical to any investor’s business strategy. However, interest rates and your investing goals may not always meet eye to eye because interest rates are also a monetary tool used by the country’s central bank to stimulate an economy and control inflation. Central banks may try to counter falling market conditions by introducing negative interest rates. It is an exciting topic, but what would be the effects on small scale real estate investors & DIY landlords?
Interest rates are amounts charged by a lender expressed as a percentage of the loan principal. Investors know that changes to interest rates can significantly impact their ability to secure real estate loans with favorable terms. The same thing is true of inflation, when the value of the dollar decreases while the cost of goods and services rises.
What most of us forget about is deflation. Deflation results in a decrease in demand as consumers wait to see how far down businesses are willing to drive their prices. As demand decreases, supply increases. Businesses lose money because sales go down, and individuals start to suffer as wages and employment rates also decline.
During these troubling times, central banks may step in and try to encourage spending by lowering interest rates. When the interest rate is below zero, it is officially a negative interest rate. This means that banks need to pay to keep their excess funds with the central bank instead of earning interest income — known as a negative interest rate. The idea is to encourage consumers and investors to use more loans and encourage banks to lend, which will boost demand, which will in turn drive prices up again.
Low interest rates may make purchasing rental properties more affordable, but the chances of the Federal Reserve adopting such a policy is unlikely. The most recent examples of negative interest rates occurred in the EU in 2014 and in Japan in 2016. Data shows some increase in government-held bond yields, but those increases have been small and have ignited an economic recovery, leaving policy makers in doubt of negative interest rates.
With little example to use as a guide, small scale property investors and DIY landlords also tread in uncharted waters. While lower interest rates means cheaper loans, those low rates also come with negative yields. An increase in supply usually means that real estate prices will go down, making properties more affordable. But keeping your investment cash safe from additional fees in a negative interest rate environment would be difficult, if not impossible. Growing your down payment funds would be similarly hard.
For these reasons, small scale property investors experiencing a negative interest rate economy may find a mixed of benefits and drawbacks. Successfully navigating it will require a great deal of skillful business maneuvering and a solid business plan designed to hedge against the falling economy.