The Fed Got it Wrong!
The era of favorable lending rates has officially come to an end. The Federal Reserve has signaled clear plans to raise rates to fight inflation, and the effects can be felt throughout the economy, especially in the real estate market. In today’s newsletter, you will learn about the Fed’s fight to combat inflation, rising bond rates, and the impact on the real estate market. Most importantly, you will learn more about high-yielding investment opportunities that reflect the current market environment of rising interest rates.
Fed Fights Inflation
U.S. inflation surged to a new four-decade high of 8.5% in March 2022, up a whopping 5.9% from this time a year ago, driven by skyrocketing energy and food costs, supply constraints, and strong consumer demand.
The Labor Department said the consumer-price index, which measures what consumers pay for goods and services, in March rose at its fastest annual pace since December 1981, up from the 7.9% annual rate in February. Rising prices have been unrelenting, with six straight months of inflation above 6%, which is well above the Federal Reserve’s (Fed) average 2% target.
Rising inflation rates have cranked up the pressure on the Fed to raise interest rates this year to lower pressure on the economy. In March, the Fed raised the targeted federal funds rate by a quarter-point to 0.25%-0.5%, for the first time in three years and signaled further rate hikes moving forward. The Fed is now eyeing rate hikes at each of the six remaining meetings this year, with the federal funds rate potentially reaching 1.9% by year's end. In addition, the Fed announced that it would reduce bond holdings and slow down future purchases.
Soaring Bond Yields Impacts on the Economy
The mere prospect of an increase in the federal funds rate has sent the yield on government bonds soaring in recent weeks. Treasury yields largely reflect investors’ expectations for short-term interest rates set by the Fed. When the Fed raises rates, or signals it is about to do so, investors tend to sell government bonds, sending their yields higher. That is what is happening now in quite a dramatic fashion.
Rising treasury yields, in turn, are cascading throughout the economy in the form of higher borrowing costs, squeezing households and businesses alike. Car loans, credit cards, and corporate debt all stand to get more expensive as rates rise. For example, the average rate on a new-car loan with a five-year term reached 4.21% in early April, up from 3.86% at the beginning of the year, according to Bankrate.com
Mortgage Market
No one is feeling the effects of higher borrowing costs quite like the American home buyer.
The 30-year mortgage rate is tethered to the yield on the 10-year Treasury, which is rising in anticipation of future rate increases. Once more, the Fed’s decision to reduce its holdings of mortgage bonds means issuers must offer higher yields to attract investors. This translates to additional costs that lenders pass on to borrowers in the form of higher mortgages rates.
These higher rates are likely to push some potential homebuyers out of the housing market and reduce overall demand. There are signs that it has already started to happen. Mortgage applications in March 2022 fell 5% compared to the same period a year ago, (9% in the last week of March alone), according to a press release by Mortgage Bankers Association.
Higher rates will make monthly mortgage payments, which are already at the least affordable level since November 2008, even less manageable for the average, everyday homebuyer. A median American household will need 34.2% of its gross income to cover the average mortgage payment on a median-priced home in January 2022. That is up from 29% a year earlier.
Effectively, homebuyers are being impacted by a double whammy. In early 2021, it was largely a function of double-digit increases in home prices that were negatively impacting affordability, but now, higher rates are weighing on affordability as well. Rising incomes are only marginally offsetting the impact of higher prices and interest rates. Consequently, the Home Ownership Affordability Monitor Index is at its lowest level since November 2008.
What Does it Mean for Investors?
Investors should look for low-risk and high-yield projects, such as short-term construction lending options that have become available in recent weeks. These construction loans pay between 10% to 12% and are on 6-12 month terms.
Real estate lending is an attractive and easy way to earn an income above the inflation rate. Our team has specialized in recommending investments with low-risk and high-yield profiles.
Our classic 3-5 year term loans are still available at healthy 9-10% interest rates (out-pacing the current rate of inflation). These loans are on fully renovated properties with long term tenants currently in place with conservative loan to values at 70% and under.
Please don’t hesitate to reply to this email or contact client relations manager Noah Jones directly at 971-275-2916.
