When we use a credit card, buy a car, get a home mortgage or deposit money in a bank the interest rate is something we need to know about. It sometimes seems that the interest charged on a credit card is very high while the interest we make on our bank accounts is very low. It seems this way because it is true. Credit card interest relates to giving millions of users what is known as an unsecured line of credit. This means that there is no firm assets as the basis for giving a loan to a cardholder. Thus, if a cardholder defaults (doesn’t pay) on the debt the credit card company most likely has to absorb the cost. This means they spread that loss over millions of other card holders in the form of higher interest charges and fees.
When we put our money in a bank, however, we are often faced with a ridiculously small interest rate paid to us. This rate of return on our money is often times .05% or less! Even with the recent modest rise in rates that bank rate of return is often below 1.5%. Why is this? Are banks just greedy?
What banks do is take your money and pool it with other depositors’ money and lend it to others-for home mortgages, business loans and the like. The bank then makes a profit between what they pay their depositors (you!) and what they make on their loans. Thus the low rate of return to the long-suffering depositors.
This is one of the great things about owning premier commercial real estate. The rental income that our corporate tenants pay brings a much higher rate of return (interest rate) than most banks would ever pay!
How are interest rates decided? This is where the story gets a little more complex. Our country has a Federal Reserve Bank that meets regularly and decides what the federal funds rate will be. This rate affects short-term interest rates and is the rate on funds lent overnight between member banks. This rate also affects medium-term rates. The longer rates, those say for ten or more years, act independently but are also somewhat reactive to the Fed Funds rate.
The Federal Reserve can raise rates to raise the cost of money and slow the economy down if there is too much inflation. Or it can lower rates to stimulate economic activity if necessary.
How do interest rates affect commercial real estate? Lower rates are generally good for real estate. When the cost of borrowing is low people tend to buy real estate. When rates rise people will sometimes shy away from real estate because the cost of money is higher. This can be true with the properties we deal with at RealyInvest. Generally speaking, however, higher rates an mean more economic activity and sometimes higher rents. So, each investing environment is different.
The best rule of thumb is to buy and hold for the long term. Warren Buffet said it best, “The stock market is a transfer of wealth mechanism from the impatient to the patient.” The same is true for commercial real estate. Buy, own, build wealth over time.