Over the last decade, interest rates have fallen to unprecedented levels. This made buying real estate interesting for many people because it could generate returns but also preserve assets. This development has led to rapidly growing demand, rising prices and the belief that real estate investments will continue to be an indispensable part of individual asset allocation for a long time to come. However, this has changed with the increase in the key interest rate. You will find important information about this in this blog post.
A look at interest rate developments in the recent past
Over the past twelve years, interest rates have been at historically low levels. In addition, there were sometimes even custody fees on demand deposits. This led to many people seeing their assets at risk and looking for alternatives. At the same time, real estate financing prices have fallen, meaning more and more people are interested in buying houses. The main focus was on three usage concepts:
- Self-use
- Speculation on rising prices
- Generating returns through rental
As more and more people recognized worthwhile investment potential, the demand for real estate continued to grow, which, in conjunction with the limited construction activity, led to rising prices. As a result, demand grew again as more and more investors expected prices to rise – especially in metropolitan regions such as Frankfurt, Munich or Berlin.
However, there is one circumstance that should not be neglected. Even though real estate, in contrast to other forms of investment, has a stable real value, current developments still carry a certain risk of market overheating and the formation of bubbles. The main focus here is on falling prices, as is conceivable given the current interest rate developments.
Inflation makes interest rate increases necessary
There is currently a global increase in inflation rates, especially in the USA. Here the value rose to 8.3 percent in April of this year. For comparison: in 2020 the average inflation rate was 1.25 percent. The values were similarly high in Germany (7.4 percent in April 2022 after 2.3 percent in June 2021). The most important reasons for this include increasing CO²-Prices, raw material shortages and international trade conflicts.
Scarce raw materials
The COVID-19 pandemic must be seen in close connection with the ongoing shortage of raw materials. There was a significant decline in production capacities and production volumes, especially at the beginning of the pandemic. As a result, suppliers of raw materials also reduced their production. However, after many pandemic control measures expired, this could not immediately be raised back to pre-crisis levels, while demand increased significantly.
Another reason for inflation is the rising energy prices, which are due to the significantly increased prices for coal and gas. One of the initial main reasons for this is the low filling level of European gas storage facilities last year. This was due to the fact that the Russian Gazprom group delivered less gas to Europe via pipelines through Ukraine – according to some experts, in order to hold a bargaining chip for the “Nord Stream 2” Baltic Sea pipeline, which had not yet been canceled at the time . The low gas supply was then met with significantly increased demand after the Corona crisis. The result: rising prices.
At the moment, the situation in Ukraine is primarily affecting prices. After the United States and Saudi Arabia, Russia is the largest crude oil producer in the world. Prices have recently risen significantly due to fears about limited security of supply in the future.
CO2-Pricing
Industrial companies and power plant operators based in the EU must emit CO2-Keep emission certificates. Prices have risen significantly in recent months. For many years they were just ten euros per ton, but in 2021 they rose to more than 60 euros per ton. This has led to a significant increase in the cost of energy production. The coal sector is particularly affected, as it produces very high levels of CO2-Emissions. As a result of this development, prices for end consumers have also increased.
International trade conflicts
The supply chains have been affected by serious problems for months. The reasons for this are a lack of overseas containers and insufficient freight capacity, which can be attributed to global trade policy conflicts. As a result, containers are increasingly accumulating in the USA. There are also pandemic-related restrictions at important Chinese transshipment ports.
Other causes
There are also numerous other problems that are driving the current shortage of raw materials and inflation. What should be mentioned here is the increasing demand for cobalt and lithium in e-mobility. The demand for high-purity silicon and gallium as a result of the semiconductor boom and production losses for platinum group elements in South Africa should also be highlighted here.
The associated inflation has had a serious impact on many economic processes. Due to the devaluation of assets, citizens saved less and less and invested increasingly in material assets. This in turn restricted banks' ability to provide loans to companies that need to finance investments. This led to restrictions in production and increasing unemployment. In order to counteract this development, both the FED and the ECB have decided on unexpectedly significant interest rate increases.
The consequences of higher interest rates
Rising interest rates have a variety of influences on property buyers and owners. The following factors are particularly noteworthy.
Real estate buyers
As interest rates rise, loans become more expensive. This also increases the monthly burden for everyone who finances a property. This impacts in two ways.
On the other hand, not everyone who wants to buy a property will be able to pay for financing anymore. This reduces demand, which is currently not a problem as there is excess demand. However, if the interest rate lock-in period for many financing options expires after ten to fifteen years and buyers need follow-up financing, this can change quickly. Under certain circumstances, it may then be necessary to continue financing at significantly worse conditions, which not every buying party can bear.
But there is also a second impact. If more properties have to be sold because follow-up financing cannot be met, more properties come onto the market. If this initially relaxes the demand situation, then on the other hand an increase in prices may soon follow. Then real estate becomes unaffordable for many people due to rising loan rates and increasing supply meets falling demand. This can be dangerous if houses have to be sold due to failed follow-up financing. The banks then have to contend with loan defaults because the sale of mortgaged properties can no longer generate enough proceeds to cover the costs incurred.
owners
If demand falls due to rising interest rates, this can be problematic for those who have bought property to hedge assets against inflation. Then prices drop and they may get less than they paid when they sell.
What buyers can do
First of all, it is important not to underestimate the development, but also not to overestimate it. Here it is advisable to take a look at interest rate developments over the past ten years. Then you can see that many borrowers have agreed financing at 3.2 to 4.0 percent. If interest rates rise moderately, this is not a problem for these people at the moment. The installments can continue to be paid. However, things can become dangerous in the event of an economic downturn with a sharp rise in unemployment. But here too the rate was at a significantly higher level in 2011 (7.1 percent compared to 5.7 percent today).
The most important tip is to secure the interest rates, which are still very low overall, for as long as possible and to take care of follow-up financing as early as possible. Here you can use a forward loan, for example. However, since interest surcharges apply, the offer should be carefully calculated beforehand.
