Increase in Interest Rates: How will it affect the housing and rental markets?

Following the record high annual inflation rate of 8.1% recorded in May across EU economies and a further increase to 9.6% in June 2022, the ECB announced earlier last month their decision to raise interest rates by 50 basis points. The monetary policy decision that came into effect on July 27th 2022, aims to counter inflationary pressures in the Eurozone and stabilize surging prices, notably energy prices which is the main contributor to the annual Eurozone inflation rate spike (accounting for +4.19 percentage points, pp).

What are the repercussions of higher interest rates on the real estate market?

The mechanism in which a rise in interest rates is expected to affect the market is quite straightforward: the cost of borrowing will increase as the leading standard for mortgage loans becomes tighter and as such, the number of qualified individuals for home mortgages will decrease. As a result of housing purchase becoming less affordable, the pool of renters on the market will increase. Moreover, as demand for mortgage loans decreases, it is usual to expect that housing prices will follow the same decreasing trend. However, following the economic climate in the Eurozone – unbalanced dynamics of supply and demand, supply chain issues, and the peak of home buying age for millennials – housing prices are not expected to decrease significantly at this time. Although rent tends to increase in this economic climate, rental costs are generally still favored over mortgage payments. Consequently, owners of rental property homes will observe a rise in demand and the rental market will tend to become more expensive as well.

What does this mean for investment portfolios that focus on prime rental properties?

The increase in rent prices steaming from higher interest rates is expected to result in an increase in yields deriving from investment portfolios that focus on high-end rental properties. This suggests that a rise in interest rates does not always mean bad news. Quite contrarily, this increase is a good signal for investors to explore funds which contain prime real estate properties and other inflation hedging assets. This is especially true in the prime property segment in Lisbon in particular where rental supply cannot keep up with rental demand. This is evident in portfolios initiated by EQTY Capital where yields being achieved are surpassing expected levels.

What does this mean for developers?

The decrease in the demand for mortgage loans has a direct impact on the demand for home purchase, and as such will inevitably influence a developer’s pipeline. As interest rates increase, development projects are expected to slow down, especially for those that have thin financing margins or targeting middle income buyers who typically rely on financing.The easing of housing prices steaming from lower levels of demand for housing purchase, tends to push developers to focus on ‘built-to-rent’ projects. This strategic shift on the developers’ part aligns with EQTY Capital’s investment strategy, which focuses on attaining the highest yields for each asset type during the life of the Funds.