INTEREST RATES - VARIABLE OR LOCK IN?

One of the most frequently asked questions I receive from Real Estate investors regarding interest rates is, "do I lock in a rate or ride the variable rate". Not a simple answer.

It goes without saying the individual property and the owner's financial situation are critical components and have a significant impact on the final decision, however, my intention with this posting is more a general call on the degree with which interest rates might rise over the next couple of years and how to position yourself for it.

In general, interest rates tend to rise at the latter stages of an economic expansion as the inflationary heat generated needs to be contained. Think the latter stages of the dot com bubble and the latter stage of the real estate bubble. Although the side effect of rising interest rates, theoretically, is the containment of inflation, the direct effect is a slowdown of the economy. The early stage of an economic recovery is not the ideal time to be significantly raising interest rates due to the negative impact on economic growth.

Additionally, the strong Canadian Dollar has a significant negative impact on the Canadian economy. Although one could argue the strong Canadian Dollar is helping to offset the inflationary pressure coming from rising energy and commodity prices, that inflation is more a result of a depreciating US Dollar than an increase in domestic demand as all commodities are priced in US Dollars.

It is my feeling we are in for a long and slow recovery as the rest of the developed world is suffering a tremendous amount of pain that has not been resolved, however emerging markets are contributing to global growth.

In essence, I don't think the Bank of Canada will be able to raise the Prime rate significantly over the course of the next year. My thoughts are for Prime to be at 3% (a .75% rise) by the end of the year and likely sitting until crystal clear indications are present that the Canadian economy is expanding continously. With regards to fixed rates the 5yr and 10yr bond yields have moved up in recent weeks, and although this may continue modestly, I feel due to the superior image around the globe of Canadian Banks, substantial Canadian natural resources and the strength of the Canadian Government's balance sheet, inflows of foreign investment to Canadian Bonds should help to keep yeilds in check.

At Prime + 1.5% or better on commercial loans I think the variable rate is the way to go.

Enjoy your weekend....


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