Sample Scenario: What Interest Rates Will Do

March 1, 2004

To see how scenario planning works, we tapped the insights of three business planning experts—Harold (Hal) Kahn, CRB, CRS®, broker-owner of Kahn Inc., REALTORS®, in Newburgh, N.Y.; David Doeleman, CRB, CRS®, a senior vice president of Real Estate Champions, a management and sales coaching company in Bend, Ore.; and Albert J. Mayer III, CRB, CRS®, also a senior vice president of Real Estate Champions in Malibu, Calif. We asked all three to consider the possible future movement of interest rates and the impact such movement could have on a business that wanted to expand in the next year or so to capitalize on the strong market. We started with the assumption that, with interest rates near historic lows, future rate changes are more likely to be up than down. (Indeed, the NATIONAL ASSOCIATION OF REALTORS® predicts a slight rate increase in 2004.) Given that assumption, does it make sense to expand? How might rising rates affect expansion plans? Here’s how our three analysts approached those questions, based on different interest-rate scenarios:

Business Goal: 50% increase in sales force

Scenarios: low, medium, and high interest-rate environments over the next few years

Interest-rate environment: Low (6%–7%) Medium (8%–9%)High (10% or above)

Probability: 50% Probability: 35% Probability: 15%

Analysis: Expanding the sales force looks fine in this scenario, but the decision depends on whether you can add people without adding substantially to fixed costs.

Plan: Develop contingency plans to shift fixed costs to variable costs. If you add associates, you’ll incur more debt, creating higher risk. Try to expand without adding fixed costs, such as by adding home-based associates.Analysis: The company will experience an initial decrease in business and lose its marginal per-formers. There’ll be fewer recruits as opportunistic job hunters see real estate as too tough.

Plan: The company will be OK in this rate environment if it runs a tight ship. If not, profit margins will decrease as productivity, based on average sales per person, declines. Embark on expansion only after addressing efficiency issues. That includes helping your current associates maximize their productivity.Analysis: This isn’t as unlikely as it may seem. In 1980, interest rates shot up to 18 percent. The companies that survived were those that succeeded in shifting fixed costs to variable costs. If you build your fixed costs to accommodate marginal performers, then you’re sunk when the market cools off.

Plan: Expand if you’re presented with an opportunity, such as an influx of seasoned associates who are looking for a new affiliation be-cause of problems at a competing brokerage.

Probability: 30% Probability: 55% Probability: 15%

Analysis: We have low rates now, so the expansion decision wouldn’t have a great impact one way or the other on the survivability of the company.

Plan: Have adequate infrastructure and high-performing sales staff in place to handle continued strong buyer business.Analysis: Slightly higher rates are likely to return as the economy improves, job growth occurs, and the tech sector and the stock market strengthen.

Plan: Continually ask yourself whether the people you affiliate have the right skills and knowledge to perform in a changing market. Con-sider expanding if earnings—including a conservative capital return—can be increased in a reason-able time period, say one to two years.Analysis: With high interest rates, you’ll have fewer sales but more overhead if you add associates.

Plan: The decision to expand might still be sound, but extensive preparation would be needed to handle 12 percent interest rates. For example, your associates will need serious training in homeowner financing—contract sales and homeowners taking back second mortgages—and in helping customers buy homes in creative ways.

Albert J.
Mayer III
Probability: 10% Probability: 75% Probability: 15%

Analysis: Demand for homes remains high under this scenario, as low interest rates drive buyers into the market. There appears to be little risk to adding offices and associates. But as soon as interest rates in-crease and demand slackens, you’re left with increased fixed overhead.

Plan: In expanding, emphasize associate productivity training. Unless associates have been trained in methods for achieving high productivity, you face carrying a surplus of low-performing associates at a time of slackening demand.Analysis: As rates rise, so do the risks of expansion. Higher rates mean slackening demand, so it warrants looking at options other than just expansion.

Plan: Expand with caution. It takes six to 12 months and a large investment of money and energy to get solid productivity out of a new associate. Recruit full-time, highly motivated associates. Offer training and coaching. Consider virtual associates, equipped with a computer and other technology and networked into your office system.Analysis: Homebuying becomes unaffordable in this scenario, at least until the public adjusts to the new interest-rate environment. Expansion doesn’t look like a good plan.

Plan: Focus on and increase your associates’ average per-person productivity. Consider downsizing your offices and having some associates work from home, networked virtually. With smaller offices, you’re more flexible and can more easily respond to changing conditions.

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