In December 2015, the Fed unanimously decided to raise interest rates for the first time since 2006. The decision had been anticipated with cautious optimism in some circles and trepidation in others. The U.S. economy continues to improve at a modest pace—271,000 jobs were added in October; the unemployment rate hovers around 5%, the lowest in more than seven years; GDP grew 2% in Q3 2015. Many commentators believe the economy has strengthened enough to warrant a raise in interest rates.
But how will real estate crowdfunding platforms be affected by higher rates? What does a climate of rising rates mean for crowd investors—especially those who will finally be able to participate in equity crowdfunding in May 2016? (see our discussion of Title III for more on this topic)
This post explores why the Fed made its decision; what effects, if any, crowd investors may feel; and to what extent real estate crowdfunding platforms may have to adjust to a higher interest rates environment in 2016 and beyond.
Why were rates increased?
When members of the media discuss “interest rates,” they are talking specifically about the federal funds rate: “the interest rate, controlled by the Fed, which banks charge each other on overnight loans.” (FoundationsForLiving) The Fed adjusts this rate to account for inflation in the economy; lowering it ought to spur growth while raising it ought to slow growth. Both actions are necessary at different times to maintain a manageable equilibrium for steady growth.
From 2008 to 2015, the Fed kept the federal funds rate at or near 0%. This past December, the Fed raised the rate to 0.25%. Fed Chair Janet Yellen believes the decision to raise interest rates reflects a renewed confidence in the U.S. economy. "While things may be uneven across all regions of the country,” Yelen said in December, “we see an economy on a path of sustainable improvement." (CBS) Yelen and many economists believe not only that the market can sustain higher interest rates, but to ensure measurable growth in the future, that now is the right time to do so.
How will I be affected as an investor?
The average American consumer likely perceives the economy as a massive entanglement of borrowers, lenders, and regulations, with the Federal Reserve often aggravating current woes in its efforts to contain them. Naturally, investors feel the impact of federal economic decisions most acutely through the lens of their daily lives. As with anyone else, the Fed's decision yields short and long-term impacts on real estate crowdfunding and its investors.
Spencer Levy of CBRE told CNBC recently that "the most immediate impact in commercial real estate is raising short term interest rates." This immediate impact is the result of banks adjusting their own prime rates in response to Fed hikes. Since the December hike was announced, Bank of America, Wells Fargo, JPMorgan Chase and U.S. Bancorp have announced hikes in their prime lending rate, ranging from 3.25 to 3.5%. (CBS)
Banks do themselves no favors by hiking lending rates, however, since bureaucratic methodologies already hamper their appeal to real estate companies. In the wake of the Great Recession, banks have become austere conservative lenders, tending to only support familiar, low risk projects, and only funding renovations on foreclosed or abandoned homes for primary residences. Constrictive Fannie Mae general requirements often result in real estate companies waiting weeks for loans to be approved, sometimes in diluted form. Hence, when banks raise their lending rates to account for higher federal interest rates, qua what has occurred in the past month, real estate companies may have even less reason than before to seek bank financing.
Crowdfunding platforms, in contrast, offer a financing option that includes a much greater number of financiers, a much quicker turnover time, fewer regulations, and rates that remain constant in comparison to banks. As a result, crowd investors may not feel the consequences of rising interest rates in the short-term. Furthermore, the decision may comport with the SEC’s recent crowdfunding legislation to boost the legitimacy and popularity of equity crowdfunding in the long-term.
Although rising interest rates more greatly affect mortgage rates than real estate investments, the impact on mortgage rates may be small this year. "Long-term interest rates will not spike in response to the Federal funds rate increase," said Freddie Mac's chief economist Sean Becketti. "While we expect the 30-year mortgage rate to be above 4 percent in early 2016, we anticipate rates will gradually increase, averaging 4.4 percent for the year." (CBS) “Gradually” is the key word in that assessment, inferring a slow, measurable change that gives the market ample time to adapt. Furthermore, David Clark of Marquette University and the Wisconsin Realtors Association believes the effect on mortgage rates will be negligible because rates have been so low for so long: if the Fed is able to keep inflation steady, “the effect on long-term rates should be relatively minor”. (WXPR)
Positive economic gains from the initial rate increase will certainly inspire confidence for further Fed increases, which could total 100 or more basis points over the course of 2016. However, some think it unlikely that Janet Yellen will promote another interest rates hike for March when she delivers her semi-annual report to the Senate Banking Committee this week—due to to first-quarter economic uncertainty about global financial markets, crude oil prices, a stalling U.S. economy, and declining bond market expectations about inflation and rate hikes. (CBS) But assuming more hikes are announced, mortgages in certain coastal cities will absorb the most substantial impact, and short-term borrowing rates do not directly drive the longer-term interest rates that real estate companies are more concerned with. (Money; Crowdfundinsider)
The Fortitude of Crowdfunding Platforms
Real estate crowdfunding platforms effectively safeguard certain parts of the housing market from risks posed by the financial sector, while being fundamentally safeguarded from those risks. The government oversees the practices and behavior of real estate crowdfunding platforms without interfering in crowdfunding transactions. This means no bail outs of real estate companies or attempts to save investor funds in the event of default. The government can only indirectly facilitate an environment conducive to real estate investing. Otherwise, the risks involved in real estate crowdfunding are inherent and limited to the crowd, the company, and the platform. End of transaction.
The Fed purports to have acted in the economy’s best interest when it raised interest rates in December. This may be so: in spite of recent bad news, there are more qualified home buyers than a few years ago; there is more new construction, and hence new listings to market; and homeowners have regained considerable equity since the Great Recession. (Washington Post) Real estate crowdfunding occupies a relatively secluded corner of an improving housing market, and will continue to grow without impediment by, and perhaps benefiting from, a timely rise in rates. Investors, real estate companies, and crowdfunding platforms will likely feel the December rates hike, and any future hikes, as a passing breeze as they are brought together in 2016.
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