The effect of rising interest rates:case Finnish housing investing

The season of extremely low interest rates has lasted several years, and this can be one reason that housing investing is very popular nowadays. Combining of the surveys made by Finnish Landlord Association (2017) and Danske Bank (2017) show that the young generation (18–29 years old) owns the biggest part of the private housing investments in Finland and apartments are usually highly leveraged. According to surveys, the majority of investors enjoys capitalization rate from 3% to 7 %, but 23% of investors does not know or does not ever calculated the profitability of their investment. At the same time, 53% of investors does not hedge against the rise of interest rates. High leverage ratio, investments done only during the low interest rates, no hedge and ignorance of the profitability of own investment is dangerous combination. This paper focus on the effects to investor’s housing income when the interest rates are rising in the future for a reason or another. The logical approach to this question is to examine capitalization rates (CAP rate) of leveraged housing investor. CAP rate is a simple formula to measure the profitability of real estates or housing units. The original layout, net operating income divided by market value, does not usually consider the possible leverage. However, housing investing is generally highly leveraged, so we do several assumptions to capture the realistic behaviour of leveraged investors and then modify the formula to respond the assumptions. The results of our study are in line with the tightened loan cap regulations set by Financial Supervisory Authority of Finland in July 2016. 100% leverage ratio is not recommendable, but the negative effects of rising interest rates decline sharply when the leverage ratio declines. Our study provides practical approach to consequences of a possible interest rate rise to Finnish housing investing from the private housing investor’s point of view. The paper works also as a guideline to new private investors to illustrate the interest rate risks better. The provided CAP rate formula of leveraged housing investing helps new investors to figure out the realistic profit of their investments