When investing in real estate, it is crucial to check the loan terms set out at the time of purchase, bearing in mind that borrowing at variable interest rates involves constant exposure to interest rate risk.
The Financial Services Agency has tightened its policy on real estate loans, as shown by the administrative sanctions recently imposed upon two major real estate lenders, Suruga Bank and Seibu Shinkin Bank. Whilst this is important news for potential buyers, those who have already borrowed money are not immediately affected.
Rather, they should be paying close attention to developments in interest rates that could change current cash flows. Here we consider interest rate risk and real estate financing.
Correlation between Japanese and American interest rates
Japanese interest rates tend to follow those in the US. In other words, if the US raises interest rates, Japanese interest rates tend to rise too.
Up until last year, the Fed had said it would raise interest rates in the United States in stages, but this year it plans to temporarily halt the rate increase. This is due to global economic uncertainty stemming from US-China trade friction and the Brexit crisis in Britain. Rather, there are even some reports that interest rates will be lowered.
In this sense, the risk of interest rate hikes in the next year or two is limited, but if we are investing in real estate in Japan, the global situation must not be ignored.
In particular, the US economy indirectly affects interest rates on real estate loans, so it is recommended that you at least check interest rate news when considering your future financing strategies.
Correlation between interest rates and real estate transactions
Of course, if the interest rate rises, the monthly loan repayment will rise. If the interest rate rises at the same time and pace as rent prices increase, there is no problem. But in reality, rent does not always rise in conjunction with interest rates.
When interest rates rise, the number of real estate transactions generally declines because the size of the monthly loan repayments increases, resulting in fewer profitable transactions.
What will happen if the number of real estate transactions decreases? Even if interest rates rise, the number of people who want to sell real estate will not decrease. But there will be less demand for properties so the real estate prices go down. In this way, interest rates affect property sales prices.
Consider future real estate financing and strategies
What strategies should you take to prepare for a future rise in interest rates? There are many ways to hedge this risk.
A typical hedging technique is to switch to fixed interest rate loans. However, in most cases, the floating rate is lower than the fixed rate, so it is difficult to decide when to fix it.
You may want to simulate this to help you decide. For example, a simulation will compare the increase in monthly loan payments caused by an interest rate increase of 0.5% with the cost of fixing the current interest rate. If, according to the simulation, the cost is much lower when it is fixed it is worth considering.
Another way of hedging is to reduce the number of outstanding bonds by making early repayments. This is also useful for the future sale of the property.
The lower the variable interest rate loan amount, the lower the interest rate risk. Also, the smaller the amount of the remaining bonds, the lower the remaining bonds become at the time of selling the property, and the lower the possibility of losing the difference. This gives you a better chance of selling when you want to, so advance payments can also be a good way to sell.
Even news that is not directly related to real estate investment, such as US-China trade friction, often indirectly affect real estate investment. Interest rates, in particular, have a major impact on real estate investment, so pay close attention to these world developments.