Real Estate Investors—Time to Get Off the Sidelines as Interest Rates Drop

Published on September 23, 2024

Real Estate Investors—Time to Get Off the Sidelines as Interest Rates Drop

What goes up must come down and that includes the historically high interest rates that have challenged American borrowers since 2020—real estate investors and home buyers—when mortgage rates doubled. While the Federal Reserve’s interest rate increases helped slow the economy and tame high inflation, many real estate investors have been waiting for more favorable rates to enter the market again.

What does the Fed do?

The Federal Reserve controls the federal funds rate; this rate determines the interest charged in overnight cash reserve transactions between banks. The federal funds rate affects overall borrowing costs (think credit cards, loans, and mortgages) because lenders usually set their rates based on this Fed-determined range.

For real estate investors who’ve been waiting on the sidelines, there’s good news. At its September 18 policy meeting, the Fed lowered the federal funds rate by .5%, bringing it down from the 5.25-5.5% range to 4.75-5%. This is its first rate cut since 2020, when, at the start of the COVID-19 pandemic, the federal funds rate was 0-.25%!

Some sources predict a Fed fund rate close to 3% by the end of 2025. We encourage everyone to follow announcements from Chairman Powell about projections on the federal funds rate going forward, as it will affect investment decisions.

What’s happening with mortgage rates?

Some good news is that mortgage rates have been falling in recent months with the expectation of the Fed lowering interest rates on September 18. Here’s a look at the average 30-year fixed rate, which is heading in the right (lower) direction:

• The rate was a bit under 3% in 2021.
• It was at 7.79% last year and is now 6.2%—a significant difference for borrowers.
• Wells Fargo estimates the 30-year fixed mortgage rate will average 6.5% by the end of this year and 5.9% by the end of 2025.

How mortgage rates affect the real estate market

High mortgage rates result in lower buying or investment levels due to the higher borrowing cost. Self-directed IRAs that make real estate investments may also need to finance part of that investment with a non-recourse loan in which—should the IRA default on the loan—the lender’s only recourse is to foreclose upon the real estate used as collateral.

High rates also drive down prices and can tighten inventory in the residential market. Sellers may hesitate to list their home during a high interest-rate environment and homeowners who locked into a very low rate during the pandemic (when they could get financing at 3%) may not be able to afford to buy something else afterward at higher rates.

Conversely, lower borrowing costs bring more buyers into the real estate market and drive up sales prices due to higher demand. This could mean that real estate investors are in a sweet spot right now—with prices not yet rising dramatically, demand not yet overheated, and borrowing rates at a more comfortable level than in the last few years.

• Bankrate reported on CoreLogic’s most recent home-price analysisthat said home prices rose 4.7% from June 2023 to June 2024, and it forecasts continued price growth of 2.3% by June 2025.
• Fannie Mae’s latest Home Purchase Sentiment Indexincreased slightly in August to 72.1, with a survey-high 39% of respondents saying they expect mortgage rates to decline in the next 12 months.

Self-directed investors take note!

Real estate investing is sensitive to interest rate changes but with lower rates ahead, more investors can afford to include this asset within their self-directed IRAs thanks to less expensive financing. Real estate investment trusts (REITs) typically do well in a lower-interest rate environment, so investing in these assets (rather than investing in a property directly) may also benefit self-directed investors.

If you are investing in a property, make sure to retain enough cash in the account to cover maintenance and repair expenses, property management fees, and other related costs associated with the asset. All investment income derived from the real estate must flow directly into the IRA, where it will grow with the same tax advantages as in a typical Traditional or Roth IRA. Your self-directed IRA can also partner with another one to make the investment and pool funds to make a direct cash purchase.

As always, you can rely on Next Generation Trust Company to provide the education and information you need to understand investing in alternative assets in a self-directed IRA. We invite you to join our mailing list and get webinar announcements, or schedule a complimentary educational session to learn more about self-direction as a retirement wealth-building strategy.