On today’s show we are talking a deeper look at the rising interest rate environment and making sense of the current market conditions.
Yields on the 5 and 10 year treasury have advanced faster than the actual rate increase. Bond investors are clearly looking into the future and trying to telegraph the destination of the rate increases the Fed has planned over the next two years.
The rise in rates has already decreased demand for debt in the residential market. As we reported yesterday, the demand for residential mortgage loans has already fallen by 33% as reported by Wells Fargo.
But we need to distinguish between the residential homeowner mindset and the investor mindset.
The residential homeowner is focused on ensuring expenses are minimized and cash flow is strong enough to afford the daily necessities and perhaps a few luxuries. This is analyzed simply, crudely as a snapshot is time. Is the cost of home ownership below 30% of households income? Yes or no.
But as investors we take a step back and look over a longer time horizon.
If borrowing costs are at 5% and inflation is currently running at 8.5%, then we are actually experiencing a period of negative real interest rates. The value of that loan is falling with each passing month.
If these inflation rates remain elevated for any sustained period, borrowing makes a lot of sense as an investor. The interest is deductible on an investment property and the lender is actually putting cash in your pocket each month. I realize that there is no actual cash transaction happening. But if you are repaying the loan with future dollars that are worth less than today’s dollars, and the interest rate is less than the rate of inflation, the bank is virtually giving you free money for the entire time that inflation remains elevated above your interest rate.
Host: Victor Menasce