As was widely expected, on March 15th the Federal Reserve announced that it was raising its prime interest rate—the interest rate at which banks lend money to each other—by 0.25%, to a total of 1%. This was the second such increase within the last three months, but only the third such increase since the rate was dropped to 0.25% back in 2008.
The Federal Reserve was motivated to raise the interest rate twice in only 3 months due to the steadily falling unemployment rate and other indicators that suggest that the economy is on the rise, and no longer needs the assistance of near-zero rates to drive lending and the real estate market. In fact, it’s believed that we are due for two additional interest rate increases of 0.25% each before the end of the year.
However, those considering taking out a mortgage shouldn’t worry. The last two increases had a negligible impact on mortgage and new borrowing rates, and this will likely be the case with March’s hike. Where the increase will be felt is in the short-term loans used to finance new business development and construction in particular.
However, this increase will likely be a boon for investors.
We will likely see fund yields increase before the end of the year.
There are at least two reasons to believe that after five years of declining yields, 2017 will be the first year in which that trend reverses.
Firstly, if the Fed does indeed increase the prime rate by 0.75% before the end of the year, banks will begin offering CDs at rates of about 2.5 to 3%. This will force fund managers—including Socotra—to raise their yields in order to keep up.
Secondly, most loans made recently have an adjustable rate component. This is true of every loan that Socotra has made in the last two years. Due to the increasing prime rate, these adjustable rate loans will see a slight increase in their interest rate, consequently increasing yields as well.
While some may be disappointed that the Fed is tapping the brakes on the market, this move will help to quell the “you can’t lose with real estate” mentality that has been resurging recently, bringing some much needed sanity to the market. Capital invested into mortgage funds like Socotra’s will be much more secure due to decreased risk.
For those who still worry about the unpredictability of the market, the Socotra Fund and the Socotra Opportunity Fund loan portfolios are secured at just over 50% Loan To Value in aggregate. We are very well positioned to handle any increase in interest rates, as well as declines in market values. Thus, this is a great opportunity for real estate investors to double down on the market.