It is ironic that all the focus on the possible trade war with China and others is focusing primarily on the impact to certain industries whether it is steel, pork, high tech, services, etc… Little focus has been given to an industry that impacts more of general America than all the other special interest groups combined. The industry most impacted by the recent trade spat is real estate.
The primary cost to Real Estate
Trades spats can have an outsized influence on rates both directly and indirectly. The sharp move in rates will impact both commercial and residential properties. Rates are one of the largest drivers of real estate profitability on income properties and affordability for owner occupied properties.
Residential: The largest driver of residential real estate is interest rates. This is especially true in rapidly appreciating markets where buyers are already “stretched” to afford a property. As rates go up purchasing power goes down. Let’s say rate go up 2%, if you are buying a median priced home in Denver for $500k and putting 20% down your mortgage would be 400k. If rates increase 2%, your payment increased 8k/year and 667/month. Salaries are not keeping up with the increases in rates and therefore purchasing power declines (or is eliminated in many markets). This prices people out of the “move up” market as many will not want to give up a low interest rate (or can’t afford to).
Commercial: Commercial properties will also be impacted by increasing rates. Just like residential purchasing power will be degraded due to higher rates. Commercial properties move in inverse to rates. As rates increase prices will decrease as capitalization rates increase to compensate for the “risk spread”. For example, if treasuries reach three percent, why would someone by a property on a three percent capitalization rate? For “zero risk” the buyer could now go out and buy a treasury note backed by the US government. Instead, the purchaser would likely want a four or five percent (depending on property, etc…) capitalization rate. Remember price and capitalization rates move in inverse. So as a cap rate increases the building price decreases. Let’s assume a property has 100k in Net operating income. It has a class A tenant in a class A location driving the cap rate to around 3%. The value would be around 3.3 million. As cap rates rise due to treasury yields to 4%, this same property is now worth 2.5m. This is quite the loss for a property owner if they were to sell.
How do trade wars indirectly impact rates?
Any trade war will indirectly impact rates through inflation. When there is a trade war/tariffs, goods for consumers become more expensive. For example, let’s say that a tariff is imposed on T-shirts. Every t-shirt will now cost one dollar more at Walmart. The consumer that buys a t-shirt will pay the increased cost of the T-shirt. This same scenario is repeated throughout the economy driving inflation. Inflation in turn will drive interest rates higher as the federal reserve tightens monetary policy to ensure there is not too much inflation and we have a stable monetary policy
It is important to note that inflation unto itself is not bad. In a typical inflationary environment prices increase as the economy grows and there is more demand. In turn wages would rise in tandem with the inflation so purchasing power would not decline. In a trade war, prices are being artificially set higher (as opposed to market driven) and wages have not kept up with the increases in price. This artificial increasing of prices is what is causing our current rates to rise along with the deficit.
What does China have to do directly with rates?
As I’ve mentioned in earlier columns (China is increasing your mortgage rates), China is the largest holder of US debt in the form of treasury notes. Treasury notes are sold to finance the government. Currently the US deficit is increasing rapidly and therefore more treasury notes must be sold to finance the deficit spending. China as the largest purchase or Treasury notes can easily manipulate interest rates. If China wants rates to go up, all they must do is increase their sales of treasury notes (or decrease their buying of future notes).
Will rates be impacted by the trade war?
China’s ambassador to the U.S. wouldn’t rule out the possibility of the Asian nation scaling back purchases of Treasuries in response to tariffs imposed by President Donald Trump. “We are looking at all options,” Ambassador Cui Tiankai told Bloomberg Television, when asked whether China would consider reduced purchases of U.S. Treasuries. (source Bloomberg).
Any scaling back of treasury purchases could have a large impact on rates. The United States Treasury is issuing one of its largest asset sales as the federal budget increases. As supply increases and China decreases demand at the same time, the treasury yield will increase substantially driving up rates.
Real Estate is the real cost to the economy of a trade war.
Mortgage rates on commercial and residential real estate will be negatively impacted either directly or indirectly due to a trade war. Real estate and mortgage rates are the biggest byproduct of the recent changes in trading relationships. At the end of the day, American consumers and businesses involved in real estate will pay the price.
Additional Reading/Resources:
- https://www.fairviewlending.com/blog/china-making-mortgage-expensive/
- https://www.bloomberg.com/news/articles/2018-03-23/china-s-ambassador-doesn-t-rule-out-reducing-treasury-purchases
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).