Treasury rates are on the move! But what does this mean for the value of Real Estate (or even the home you own)? In this month’s Harbor Drive Investor, we’re going to talk about how the treasury rates (AKA bond yields) have an affect on real estate investments and valuations.
You may have noticed recently a lot of talk on financial news platforms about inflation and treasury rates/bond yield volatility and a lot of commentary from our nation’s current Federal Reserve Chairman, Jerome Powell. The Federal Reserve has many tools at it’s disposal to help control and mitigate inflation and other economic activity risks in the country. One of those tools is the treasury rates. If you follow any financial news networks on a regular basis, you’ve probably seen them talk about (among other things) the treasury rates and how they move. Treasury rates can be influenced by the FED by purchasing or selling large volumes of Bonds which affect how the treasury rates move. At times when the economic forces indicate periods of inflationary environments in our country, you can typically see higher volatility in the treasury rates.
WHY DO THE TREASURY RATES MATTER?
The treasury rates affect borrowers because many banks and other lenders borrow money at the treasury rates, then turn around and lend that money to you by adding a spread which is that lender’s profit margin. This can have a major impact on economic activity in every industry (not just real estate investing) because businesses rely on debt to grow and preserve their businesses. Maybe a business needs to buy some new equipment to keep up with new accounts and increased demand. Some businesses will use credit to finance needed inventory requirements. Other businesses may borrow capital to hire new employees so they can grow. Whatever the lending need, businesses use credit and other debt tools everyday to help them grow their businesses (economic expansion). Well when the treasury rates climb, the lenders have to charge more for that money (the borrower’s interest rate) because the lender still needs to make a certain spread (lender’s profit) over the treasury on the funds they borrow to lend to you. After all, banks are in the business of making money… So as rates increase, naturally the debt payments become higher and the borrower of said funds may not be able to borrow as much of the needed capital as they did when rates were lower.
WHAT DOES THIS MEAN FOR MY REAL ESTATE INVESTMENTS?
Shifting gears to real estate, as treasury rates climb, the same applies. Mortgage rates go up and the borrowing power is reduced. So two things can happen; 1. We suck it up and pay higher rates (no thank you!) or 2. The prices of real estate decrease (or in our world of apartment investing, CAP rates expand) so that we can still hit our target returns to our investing partners. As treasury rates increase from their historically low levels, we anticipate a lagging affect on softening real estate values. The same thing will happen in the residential home market. If you are looking to buy your first house (or second house, or 3rd, 4th, 10th, etc.), your borrowing power will be decreased as treasury rates and bond yields rise which will put downward pressure on property values. Fewer people can afford homes (supply decrease), which will decrease pricing. Just like we all learned in high school economics class! This is why we always INCREASE our exit CAP rate projections when we bring a deal to our investors. We want to be sure that we can still hit our investor targets on a deal we bring to you even if we anticipate decreases in valuations when we exit. More on this in a future article….
WATCH: In the video below, HDH co-founder Rob Overstreet talks a bit more about treasury rates and how they affect our real estate investments.
The Exciting Part!
Although our current projects may take a value hit because of expanding bond yields as discussed above, we’re expecting that and have factored in CAP rate expansion on our exit valuation projections. But, if treasuries continue to rise in the future, we expect to see some amazing investment opportunities come out in very good markets! We are licking our chops at the thought that we’ll have some very exciting new investment opportunities to bring to you shortly. In the meantime, we continue to work hard every day evaluating countless deals on behalf of our investors. Most of the deals we look at, we do not even submit offers on as they don’t hit our target investor returns. With the bond market volatility we’re seeing now, we expect to see an increase in good deals coming to the market for our evaluation to inevitably bring to you as a valued investing partner. Stay tuned as you’ll be the first to know when we get the next one under contract!
In the meantime,