Soaring interest rates can shake up the rental property market. For instance, the Federal Reserve hiked interest rates in May 2023 to between 5.25% and 5.5%, the highest level witnessed in 16 years.

Such hikes can affect the economy, so here’s a breakdown of how high-interest rates can impact buying of rental properties:

How Higher Interest Rates Affect Buying Rentals

Increased Borrowing Costs

High-interest rates mean you’ll be shelling out more to finance your rental property purchase. Your lender will charge more for the loan, which translates to higher monthly mortgage payments. That could squeeze your cash flow and dip into the profitability of your investment.

Shrinking Purchasing Power

Higher interest rates can put a damper on your buying power. Lenders often tighten their belts when interest rates rise, offering lower loan amounts to borrowers.

Mortgage rates jumped from 3.4% to 7.12% between January and October 2022. That pushed median home prices to the highest they have ever been, sending demand tumbling.

It could mean qualifying for a smaller loan than you would with lower interest rates, limiting your options to smaller or less attractive rental properties.

Cooling Demand

High-interest rates can take the heat out of the real estate market. As borrowing costs climb, potential buyers might think twice about jumping into the market or decide to put their investment plans on ice.

This can spark a more competitive market for sellers, possibly leading to lower property prices or longer times on the market. In July 2023, the National Association of Realtors reported sales had shrunk by 18.9% from a year earlier.

Renting Over Buying

High-interest rates can also affect rental demand. If would-be homeowners face steep mortgage rates, they might opt to keep renting instead of buying.

This could keep demand for rental properties steady, with more people choosing to rent over buy in a high-interest-rate environment.

Cash Flow Conundrum

High-interest rates can throw a wrench in the cash flow of rental properties. Hefty borrowing costs can lead to bigger mortgage payments for landlords. If the rental income doesn’t cover these increased expenses, it could eat into your net cash flow and profitability.

So, landlords need to crunch the numbers carefully when considering rental property purchases during periods of high interest rates or risk a mountain of debts.

Look Elsewhere for Returns?

When interest rates head north, other investment options like bonds or savings accounts might start looking pretty appealing with their higher yields.

This could pull potential investors away from real estate because lenders view the industry less favorably than other more lucrative ventures. That might affect property prices or make it tougher to find good investment opportunities.

Final Word

The impact of high-interest rates on buying rental properties can vary widely. Factors like location, local market conditions, and your personal financial situation can all play a role.

So, before diving into a rental property purchase in a high-interest-rate climate, take a hard look at your finances, do your market homework, and don’t hesitate to seek advice from real estate pros.