Blog Post No. 224
Housing market and interest rates with Hossein Fateh CloudHQ – episode 2
04/01/2024
Housing market and interest rates with Hossein Fateh of Cloud HQ “
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The discussion highlighted the intricate relationship between interest rates, inflation, and their impact on the real estate market. The guest, Hossein Fateh, CEO of Cloud HQ, emphasized that real estate valuations are directly correlated with government bond rates, such as the US 10-year Treasury or the UK’s 10-year gilt. As interest rates rise, cap rates and property valuations are affected, with higher rates leading to higher cap rates and lower property values.
Fateh explained the concept of cap rates, which involve dividing the property income by the interest rate. He stressed that the risk-free rate, represented by government bonds, plays a crucial role in determining cap rates for commercial properties. With the current increase in risk-free rates, there’s a cascading effect on cap rates, affecting property values across various sectors.
The conversation delved into the relationship between inflation and interest rates. Fateh pointed out that inflation generally makes the rich wealthier but has adverse effects on those with fewer assets. Governments often combat high inflation by raising interest rates, a measure aimed at slowing down the economy.
Concerns were raised about the potential challenges in the real estate market due to the current trajectory of rising interest rates. Fateh suggested that property owners who haven’t already fixed their interest rates might face difficulties, and those with short-term construction loans could be particularly vulnerable.
The conversation also touched on the impact of inflation and interest rates on the rental market. Fateh explained that if interest rates rise too quickly, tenants may struggle with higher rental costs, affecting affordability.
In addressing strategies for real estate investors during periods of high inflation, Fateh recommended timing the market correctly, being cautious not to buy too early, and ensuring the ability to act quickly with available cash or external funding.
The potential consequences of interest rate hikes on mortgage payments were discussed, emphasizing the challenges faced by individuals with variable-rate mortgages or those who didn’t fix their rates in time.
The conversation concluded with insights into how real estate investors can navigate high-interest rates, including the importance of timing, having a robust balance sheet, and considering the ability to raise funds externally.
In summary, the conversation provided a comprehensive overview of the complex interplay between interest rates, inflation, and their significant impact on various aspects of the real estate market, from valuations and cap rates to rental markets and investor strategies.“
Hossein Fateh, Founder and CEO of Cloud Capital and CloudHQ, boasts 25+ years of experience in data center development and operation. Formerly CEO of DuPont Fabros Technology, he oversaw its $7.8 billion sale in 2016. With a global footprint, he has managed 700MW of data center space. Committed to philanthropy, Hossein is involved in various committees and boards, contributing to institutions such as George Washington University and the Hospital for Special Surgery. His academic background includes a BA in Business Administration and an MSc in Finance from George Washington University.
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Farnaz Fazaipour:
Hello, and welcome to London Property, the home of super-prime. I’m your host Farnaz Fazaipour. Today, we’re delighted to welcome back to the show Hossein Fateh, the CEO of Cloud HQ. Welcome to the show.
Hossein Fateh:
Thank you for having us.
Farnaz Fazaipour:
So why don’t you tell us a little bit about Cloud HQ and what you do to put things into context for us before we continue.
Hossein Fateh:
We have two companies, Cloud HQ and Cloud Capital. Cloud HQ is a developer wholesale of data centers, primarily serving large tech companies like Microsoft, Amazon AWS, Google, Oracle, and Meta. We handle everything from finding locations, securing power, fiber optic routes, planning, building, and providing long-term leases to these companies.
Farnaz Fazaipour:
That’s your core business. Today, we’re talking about the effects of interest rates and inflation on the real estate market. You’re well-positioned to educate us on this subject.
Hossein Fateh:
Inflation and interest rates are directly related and impact long-term debt. Real estate valuations correlate with government bond rates. The risk-free rate is the long-term government bond rate, and real estate prices are based on cap rates, which factor in this risk-free rate. As interest rates rise, cap rates increase, affecting property valuations.
Farnaz Fazaipour:
So, cap rates are tied to the risk-free rate.
Hossein Fateh:
Yes, the cap rate is the premium on the cost of the long-term treasury. Inflation affects real estate by making the poor poorer, and governments use interest rate hikes to control inflation. The cost of goods and services, including labor, contributes to inflation. With a tight labor market, inflation becomes challenging to manage.
Farnaz Fazaipour:
How does inflation impact buyers’ purchasing power in real estate?
Hossein Fateh:
As inflation rises, interest rates increase, impacting the cost of borrowing. Buyers may need less leverage, and the cost of borrowing becomes higher. Even if the cost of debt is fixed, new buyers entering the market may demand higher returns, affecting property valuations.
Farnaz Fazaipour:
So, the entry point for new buyers is crucial in an inflationary market.
Hossein Fateh:
Exactly. Timing is crucial, and buyers need to be cautious not to overpay in a changing market.
Farnaz Fazaipour:
How can investors protect their real estate investments in a high inflation scenario?
Hossein Fateh:
Ideally, fixing interest rates long term is the best protection. Those who didn’t do this may need to sell, downsize, borrow from family, or use savings to pay down debt. Waiting for the market bottom to make strategic acquisitions could also be a defensive strategy.
Farnaz Fazaipour:
So, strategic timing and financial preparedness are key.
Hossein Fateh:
Absolutely. Being well-capitalized and having the ability to act quickly in the market is crucial.
Farnaz Fazaipour:
Switching to the impact on construction costs, how does inflation affect the cost of construction?
Hossein Fateh:
Construction costs are highly correlated with inflation, with labor and materials making up a significant portion of expenses. In a tight labor market, labor costs rise, and materials and equipment costs increase with inflation.
Farnaz Fazaipour:
So, managing construction budgets becomes challenging in an inflationary environment.
Hossein Fateh:
Exactly. Property developers may need to raise rents to protect yields amidst rising construction costs.
Farnaz Fazaipour:
Now, looking at the residential market, how do changes in interest rates and inflation affect homebuyers?
Hossein Fateh:
If interest rates rise rapidly, homebuyers with variable-rate mortgages may struggle. Those who fixed their rates earlier may fare better. Affordability becomes a challenge, and some may need to sell or borrow to cover increased mortgage costs.
Farnaz Fazaipour:
So, fixed-rate mortgages provide more stability for homebuyers in uncertain markets.
Hossein Fateh:
Yes, fixed-rate mortgages offer protection against rising interest rates, providing a sense of financial security for homeowners.
Farnaz Fazaipour:
Moving on to commercial real estate, how can investors take advantage of inflation in this sector?
Hossein Fateh:
Investors can identify properties where tenants are paying below-market rates and negotiate favorable deals. Buying at the right price and renegotiating rents when they roll can be a strategic move.
Farnaz Fazaipour:
So, finding
opportunities with below-market rents is a key strategy in leveraging inflation in commercial real estate.
Hossein Fateh:
Exactly. It’s about recognizing the market dynamics and making informed decisions to capitalize on potential opportunities.
Farnaz Fazaipour:
Thank you, Hossein Fateh, for sharing your valuable insights on the impact of interest rates and inflation on the real estate market. It’s been a pleasure having you on Love Them Property.
Hossein Fateh:
Thank you for having me. It’s always a pleasure to discuss these critical topics.
Farnaz Fazaipour:
And to our listeners, thank you for joining us on this episode of Love Them Property. Stay tuned for more engaging discussions and expert insights on the London real estate scene. Until next time, happy property hunting!