Interest rates are an important part of any investor’s business strategy. Unfortunately, interest rates and your investing goals may not always peacefully coexist because interest rates are also a monetary tool used by the country’s central bank to stimulate an economy and control inflation. In certain situations, central banks may try to counter negative market conditions by introducing negative interest rates. It is an intriguing thought, but how common are these scenarios, and what would be the effects on single-family real estate investors?
By definition, interest rates are amounts charged by a lender expressed as a percentage of the loan principal. As an investor, you know that changes to interest rates can significantly impact your ability to secure real estate loans with favorable terms. The same thing is true of inflation, when the value of the dollar decreases while the cost of goods and services rises.
But what may be less well known is that it is also possible to have times of deflation, or a decrease in prices without a similar decrease in inflation rates. According to the prevailing economic theory, deflation results in a decrease in demand as consumers wait to see how far down prices will go. As demand decreases, supply increases. Businesses lose money because sales go down, and individuals start to suffer as wages and employment rates also decline.
In situations like these, central banks may step in and try to encourage spending by lowering interest rates. In some cases, the nominal interest rate may be lowered below zero percent for a specific economic zone. This means that banks and other financial entities actually need to pay to keep their excess funds with the central bank instead of earning interest income — known as a negative interest rate. The idea is to encourage consumers and investors to use more loans and encourage banks to lend, which will boost demand, which will in turn help prices go up.
While such low interest rates may make purchasing single-family rental properties more affordable, the chances of the U.S. Federal Reserve adopting such a policy seems remote. The most recent examples of negative interest rates occurred in the EU in 2014 and in Japan in 2016. While the data shows some increase in government-held bond yields, those increases have been small and have not yet sparked a full economic recovery. Such results have left the effectiveness very much in doubt.
The impact for single-family rental property investors is similarly unsure. There are very few examples to use as a guide. While lower interest rates means cheaper loans, those low rates also come with negative yields. An increase in supply usually means that real estate prices will go down, making properties more affordable. But keeping your investment cash safe from additional fees in a negative interest rate environment would be difficult, if not impossible. Growing your down payment funds would be similarly hard.
For these reasons, rental property investors experiencing a negative interest rate economy may find a mixed bag of benefits and drawbacks. Successfully navigating it, should it even happen, will require a great deal of skillful business maneuvering and a solid business plan designed to hedge against the pitfalls such an economy might bring.