In today’s high interest rate environment, investors face a challenging decision: Should you buy real estate now and lock in high interest rates for decades, or wait for rates to drop and potentially face higher property prices?
As interest rates rise, borrowing costs increase, significantly impacting mortgage payments and the overall cost of purchasing a home. Conversely, waiting for interest rates to decline could lead to a more competitive market with higher property prices.
To navigate this dilemma, it’s crucial to consider both price and interest rate trends over the coming decades—a complex task. The best approach is to analyze historical data and draw general conclusions based on past trends. This article aims to provide that analysis.
The Economic Value of Residential Property
The economic value of residential property comprises:
- Price appreciation
- Rental income
- Depreciation
If the economic value of the property exceeds the total interest payments, the investment is justified. Otherwise, it results in a net loss. The profitability of a housing investment depends on market conditions during the investment period.
Quantifying Real Estate Investment
We quantify the profit or loss associated with a $100,000 real estate investment at different points in time. Using a fixed investment amount allows us to ignore inflation and focus purely on the impacts of interest rates and property value changes. We set the investment horizon to 15 years, corresponding to the typical length of a fixed-rate mortgage deal. Rental income and depreciation are defined as a constant share of the house price, based on realistic values.
Key Historical Insights
There are two notable peaks in the chart:
- First Peak (Early 80s): Interest payments exceeded the value of the initial $100,000 investment by more than a factor of 3. During this period, mortgage payments significantly surpassed the economic value of the property, causing investors to lose a substantial amount in nominal terms.
- Second Peak (Post-2008 Financial Crisis): Triggered by the 2008 financial crisis and followed by unprecedented fiscal and monetary stimulus, this period saw booming housing prices and lower interest payments. This has been the best period in our data for real estate investors, where some have tripled their investments.
So yes, if you consider buying a mortgage, interest rates seem to matter quite a lot.
How much do prices need to appreciate to make housing investment profitable?
During the early 80s, actual price appreciation fell short of the break-even level, whereas post-2008 prices appreciated more than what was needed to break even.
Currently, the 15-year fixed-rate mortgage stands at 5.89%. To cover these interest payments, house prices need to appreciate by at least 28.6% over the next 15 years.
The question then becomes: How likely is it that house prices will appreciate by more than 28.6% over the given time horizon?
As the chart shows, throughout the post-WW2 period, the 15-year house price changes have always been above 28.6% (green area), with the exception of a single year, 1953, where the price appreciation was slightly below the break-even level. Prior to WW2, there have been periods where the house price appreciation has been sluggish; however, it seems unlikely that these periods represent the current house price dynamics. In general, the historical trends present a rather optimistic picture for the potential real estate investors.
Conclusion: Is Real Estate Investment Right for You?
Over the last 80 years, house price appreciation has consistently exceeded the level which would make house investment profitable given the current interest rates. Housing investment may have a positive expected return; however, this does not necessarily mean that it is the best investment option in the town.
Is real estate investment right for you in today’s market? Share your thoughts and experiences in the comments below!
