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What Are Negative Interest Rates and How Could They Affect Real Estate Investors?

[Updated: Jun 09, 2020] Sep 09, 2019 by Matt Frankel, CFP
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What does negative interest rate mean?

Negative interest rates work in the exact opposite way of the positive interest rates that we see throughout the U.S. financial system. If you borrow money at 4% interest, you pay the lender back more than you borrowed -- the principal plus the interest. If you borrow money at a negative interest rate, you actually end up paying back less than you borrowed.

This may sound like an absurd concept, and until recent history negative interest rates were unheard of. However, they are quite common in many parts of Europe and Asia. In fact, 45% of non-U.S. bonds around the world currently have negative interest rates -- about $15 trillion worth of bonds altogether.

In many cases, the negative yields on government bonds have trickled down to corporate bonds and even consumer interest rates. For example, Apple (NASDAQ: AAPL) has issued some European bonds with negative interest rates, meaning that the company gets paid to borrow money. In Denmark, there have even been negative mortgage rates, which means that you could borrow money to buy a house and pay the bank less than you borrowed.

What happens if interest rates go negative in the US?

To be perfectly clear, I don’t think it’s likely that we’ll see negative interest rates in the United States anytime soon. The federal funds rate is still above 2% and the benchmark 10-year Treasury yield is around 1.5%. So there’s a long way to go before things turn negative.

45% of non-U.S. bonds around the world currently have negative interest rates -- about $15 trillion worth of bonds altogether.

Having said that, it’s certainly possible. Between the ongoing trade war and general recession fears, there’s definitely a fair amount of downside risk when it comes to the strength of the U.S. economy. Plus, the Federal Reserve is under pressure to cut rates, so if they cut rates several times before a recession occurs, negative interest rates could be a possible tool to help boost the economy.

How do negative interest rates affect mortgages and investors?

Negative interest rates would almost certainly cause an overall drop in the stock market, as it would erode confidence in the U.S. economy. Some industries would be hit especially hard -- banks in particular would likely see profits nosedive, as these businesses rely on interest income.

On the other hand, real estate could be one of the few winners if negative interest rates spread to the United States.

For property investors, negative interest rates would make borrowing much cheaper. Now, even if we saw negative Treasury yields, it’s unlikely that mortgage rates would turn negative. However, assuming that mortgage rates move in line with long-term Treasuries, there could certainly be a long way down.

As of early September 2019, the average APR on a 30-year fixed-rate mortgage is about 3.875% and the 30-year Treasury is hovering around 2%. If the 30-year Treasury yield were to fall to an unprecedented 1% or even 0.5%, this could easily result in 30-year mortgage rates in the 2%-2.5% range.

Let’s say that you’re borrowing $200,000 for an investment property. Here’s the difference that certain hypothetical mortgage rates could make on your borrowing costs:

Mortgage Rate Monthly Payment on $200,000 Mortgage (P+I) Total Interest Paid
4% $955 $143,739
3% $843 $103,555
2% $739 $66,126
1% $643 $31,580

In a nutshell, your monthly debt expense would fall and properties would cash flow better. And since less of your mortgage payment would be applied to interest, you’ll build equity in your investment properties faster.

What about REITs?

Without getting too technical, it’s important to know that share prices of real estate investment trusts, or REITs, generally have an inverse relationship with interest rates. When market interest rates fall, REIT yields tend to do the same. Lower yields equal higher share prices, which is exactly what we’ve seen as Treasury yields have fallen in recent months.

In addition, lower rates could mean that REIT borrowing costs will fall. Think about it this way -- if a REIT can issue bonds with a 3% yield and use the money to buy properties with an 8% return, its profit margin is 5%. If it can issue debt with a 0% or 1% yield, the margin gets much better. This is a simplified example but is the general idea of how REITs grow.

We might not get negative rates, but…

As I mentioned, I don’t think that it’s particularly likely that we’ll see any sort of negative interest rates in the United States anytime soon. However, it’s a mistake to think that interest rates don’t have a long way they could fall, even though they’re currently near historic lows. Rock-bottom interest rates can be a negative catalyst for many areas of the market, but real estate investors -- both in stocks and investment properties -- could be among the limited beneficiaries.

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Matthew Frankel, CFP owns shares of Apple. Bank CD rates owns shares of and recommends Apple. Bank CD rates has a disclosure policy.