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With the return of the US economy to a much more sustainable pace of economic expansion, the central bank is expected to start hiking central rates soon. The majority in the market is convinced the Feds will act in mid-September or the first of October to end three years with zero interest rates. This view is well supported by sound arguments: (1) The unemployment rate has fallen to the pre-crisis level of around 5.3%, a decline of about 5 percentage points over the course of the past five years. (2) The economy has created 12 million jobs since 2010 or a monthly average employment gain of 215,000 since the beginning of 2012. (3) So far, wage inflation and hence price inflation is still below the Fed’s target of around 2%. (4) Quarterly economic growth has averaged about 2.5% since 2010, The rebound of economic activity in Q2 which is up to 3% unit is showing the first signs of acceleration, which seems to urge higher short-term interest rates. In principle, higher interest rates exert three conflicting influences on consumer spending: First, with higher interest rates one needs to save less today to fund future spending. This income effect implies that an increase in interest rates increases current spending. Second, higher interest rates increase the benefit of saving, as greater future spending is gained by forgoing current spending. This substitution effect means that an increase in interest rates reduces current spending. Third, higher interest rates tend to reduce asset values. Reduced wealth tends to reduce current outlays; so this means an increase in interest rates reduces current spending. What does this do for the real estate industry? As interest rates increase, fewer potential homeowners can afford to purchase houses, which increases the demand for income rental properties. Higher interest rates also reduce the supply of rental income properties because builders cannot afford to build. Supply and demand play an important role in rental income property values. The demand for rental property is increasing because the number of people entering the rental market is increasing steadily each year. At the same time, construction costs, stricter zoning ordinances, and environmental factors are limiting the new construction of residential income property. Together, these trends bode well for investing in rental income property ABOUT THE AUTHOR: Eugene E. Vollucci is the Director of The Center for Real Estate Studies, a real estate research institute. He is author of four best selling books and many articles on rental income investing, real estate and taxation. To purchase a subscription to Market Cycles and to learn more about the Center for Real Estate Studies and its educational resources, please visit us at http://www.calstatecompanies.com
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