In today's dynamic economic landscape, investors seeking stability and growth in their portfolios are facing a formidable challenge in the form of rising mortgage rates. As the real estate market undergoes fluctuations, it becomes imperative to explore effective strategies that can combat the impact of increasing mortgage rates. This article aims to provide a comprehensive analysis of the best ways investors can navigate these turbulent waters and make informed decisions to protect their investments.
1. Research the Property Market Fundamentals
From a buy-to-let investor's perspective, increasing mortgage rates have both negative and positive effects on real estate markets. Investing in markets that maintain strong economic fundamentals, such as resilient economic growth, an expanding population and a housing supply shortage indicate that house prices still flourish in the medium to long-run. Rising interest rates often result in a short period of subdued property price growth, creating a potential window of opportunity for buyers as fewer individuals can afford to purchase with mortgages.
Consequently, more individuals will be pushed into the rental market due to the increased mortgages rates. In the right housing market, even a modest 1% increase in interest rates can be outweighed by the growth in rental demand, therefore, forcing rent prices up.
Recent months have seen significant rental growth in many markets of the UK. With demand at an all-time high and tenants paying portions of their rental period up front to secure properties, this creates an advantage for buy-to-let landlords.
2. Consider Buying Off-Plan Property
Buying off-plan property can be a good idea when property mortgage rates are high for several reasons:
Payment Timing: Purchasing off-plan buyers pay deposits on exchange and the remainder of the purchase price only on completion, allowing them to spread out the cost of the property. With high mortgage rates, this flexibility can be beneficial as it provides you with more control over your financial obligations.
Market Movements: Off-plan property is somewhat insulated from a turbulent mortgage market because the buyers mortgage is processed prior to completion. This means that todays market is not the same mortgage market that many clients will be obtaining their finance in. By the end of 2025, for example, the UK base rate is expected to be back down to around 4% according to Oxford Economics.
Potential Rental Income: If you are considering buying the property as an investment, higher mortgage rates may not significantly impact your income. Many cities including Manchester, Sheffield and Birmingham have seen exceptional rental demand with average rents in Manchester up 6.1%, Birmingham up 4.7% and Sheffield up 5.2% in the year to September 2022.
Potential Capital Appreciation: Real estate markets are dynamic and tend to appreciate over time. By purchasing a property off-plan, you have the potential to benefit from capital appreciation during the construction period. If the market conditions are favorable, the value of your property may increase significantly by the time it is completed, providing you with potential equity gains. Forecasted capital growth in key locations such as Birmingham and Manchester is expected to top 19% over the next 5 years.
Using an example unit in one of our Manchester developments, The Bailey, we estimate that investors can earn up to 10% on their equity in the second year of their investment with an average interest-only mortgage of 6.5% in year 2. To take a closer look at the details, request The Bailey Returns Model here.
3. Assess Your Repayment Options
One effective strategy to mitigate the impact of rising interest rates is to make mortgage overpayments when possible. By paying more than the required monthly amount, you can reduce the outstanding principal balance and potentially shorten the loan term. Not only does this reduce the overall interest paid, but it also provides a buffer if interest rates increase. Check with your lender to ensure there are no penalties or restrictions associated with overpayments.
A second effective strategy is to opt for a variable mortgage rate in a high mortgage rate environment, before changing back to a fixed. There are several advantages:
Initial Lower Rates: Variable mortgage rates are typically lower than fixed rates at the beginning of the loan term. This can result in lower initial monthly mortgage payments, making homeownership more affordable in the early stages.
Potential for Decrease: If mortgage rates decrease over time (which they are currently forecast to do so), borrowers with variable rates can benefit from lower interest charges and reduced monthly payments. This flexibility allows homeowners to take advantage of favourable market conditions.
Flexibility: Variable mortgage rates often come with more flexible terms, such as the ability to make additional payments or pay off the mortgage early without incurring penalties. This can provide borrowers with greater financial freedom and the opportunity to save on interest costs.
Short-Term Ownership: If you plan to sell the property or refinance the mortgage within a relatively short period, a variable rate mortgage may be suitable. With this, you can take advantage of the lower initial rates and potentially avoid higher rates in the long run.
It's important to carefully assess your financial goals, market conditions, and risk tolerance before deciding on a variable mortgage rate in a high mortgage rate environment. Consult with a mortgage advisor to evaluate the pros and cons and determine the most suitable option for your specific circumstances.
4. Consider Historical Differences
Buying a home as mortgage interest rates are rising is nothing to fear. From a historical standpoint, a 5% mortgage rate is still relatively low. Stress testing criteria now means that the housing market in the UK is more resilient than ever. Typically during the mortgage process, applicants need to evidence that they can afford mortgage rates considerably higher than the one they are applying for, typically around 8% - 10%.
During the 2008 global financial crisis, rental growth remained fairly flat at between 2-3% over the period which limited investors in their ability to cover mortgage costs. Alternatively, rents in the UK are increasing at a blistering pace. In the year to January 2023, average rents increased by 11.1%. This further supports the argument of an extremely robust buy-to-let market with growing returns to cover increased mortgage costs.
Fears of market turbulence are valid but one needs to consider all environmental factors in order to assess the extent to which history can repeat itself.
Intelligent buyers can take advantage of the current market conditions. However, it is crucial for buyers to seek guidance from experienced real estate professionals with extensive knowledge. These experts, who have personally owned multiple properties and facilitated numerous real estate transactions, can provide invaluable advice. Collaborating with such experts instills a sense of confidence, knowledge, and security, empowering prospective investors to make informed and financially sound decisions. If you would like some more information on how to navigate the current market, you can reach out to one of our experienced wealth managers here.
