The interest rate dilemma
The recent uptick in interest rates, though long anticipated, has nevertheless caused considerable reflection on the part of real estate investors. Did I miss the boat? Have interest rates risen beyond my comfort level?
Perhaps its time for some perspective
We’ve certainly enjoyed a protracted period of low and attractive rates. Perhaps its a useful reminder to put current rates into perspective. Looking back over the past 10 years, the average 5 year fixed posted residential mortgage rate was 5.39%, 10% higher than present levels. We are presently still enjoying residential mortgage rates lower than the 10 year average posted rate. In fact, whether you consider posted or discounted rates, and a 10 year or 20 year horizon, the overall slope of the rate curve is downward.
What about commercial rates? These are more difficult to track of course, as individual lender’s cost of funds differ. A good proxy is the yield on the corresponding Government of Canada bond of similar maturity. If we look at 5 year GoC yields, the average yield on a quarterly basis, over the past decade, was 1.77%, exactly the same as present bond yields. Now one could argue that borrower rates have risen, however there is still active competition among lenders for quality investment opportunities.
Nobel laureate Nils Bohr once famously said “Prediction is very difficult, especially if its about the future”. There does however appear to be a consensus that there is ongoing upside to rates, over the short to medium term. The Canadian economy seems fairly robust, and though inflation seems to be in check, policy makers appear to be of the mind that the economy is showing solid growth, and there will be continued pressure to put the brakes on, with another rate hike by year end, not out of the question.
What is a borrower to do?
Yes, interest rates are important. But often overlooked is the term of your financing. In our post entitled Mortgage Term Preferences, we outlined borrower preferences for length of mortgage terms selected. The importance of developing a real estate strategy, particularly in the face of interest rate uncertainty, cannot be overstated.
Are you a buy and flip investor, or are you interested in a long term hold? How long are your primary Lease terms? Perhaps you acquired the property at an advantageous price. You may have created value by releasing to stronger tenants at higher rents. Perhaps you’ve updated the property. Are you now locked into an inappropriate mortgage term, unable to “release equity” to leverage this added value?
Real Estate strategy is important
What is your portfolio strategy? If you have several assets, conventional wisdom would suggest that you stagger your mortgage maturities.
What is your property specific exit strategy? If you’ve maximized value, and little future value upside is available in the short term, do you want to position yourself so that you can entertain an Offer to Purchase without having to consider potentially costly mortgage prepayment penalties?
Conversely you may have acquired the property with the expectation that it will represent a major part of your future retirement strategy. Is a longer mortgage term more appropriate, with certainty of mortgage payments? Recent interest rate increases will undoubtedly inform your decision as to length of term.
The best offence is a good defense, is an adage applied to many fields of endeavor. Perhaps its time for real estate investors to take a page out of that playbook too.