SS182: The Impact of Interest Rate Changes on Real Estate Investing

SS182: The Impact of Interest Rate Changes on Real Estate Investing

Real estate prices and interest rates are closely correlated. In this episode, Charles discusses the impact of interest rate changes on real estate investing.

Watch The Episode Here:

Listen To The Podcast Here:

Talking Points:

  • Interest rates and the cost of debt are major factors when investing in real estate since, in most situations, real estate investors fund most of their purchases with debt. When interest rates change, these changes can significantly impact real estate investors in several ways.
  • The Cost of Borrowing. One of the most obvious changes is the cost of borrowing. When interest rates increase, real estate investors need to rework their investment underwriting with the new cost of debt to see if the deal still makes sense.
  • This can be tricky with short-term holds because investors need to purchase the property initially and resell it at a profit in the future. If interest rates are increasing, they need to ensure that when their renovations are complete, the new buyer can actually obtain financing and purchase the property while compensating the seller to make it worthwhile.
  • Interest rates are still a factor with long-term holds; if the investor obtains long-term fixed-rate financing, say a 10-year or longer loan term, and the property is currently cash-flowing or very close to it with the current interest rates, this is a much lower risk investment. cp, etc. In 10 years, the property will most likely be valued much higher than it was when purchased, so it can easily be refinanced, even if interest rates are higher.
  • If interest rates drop, this is typically a benefit to the investor since, in many interest-rate-decreasing situations, the value of rental property increases since real estate becomes a more attractive and sought-after asset class.
  • Property Prices. Investment property values, especially commercial real estate values, correlate heavily with interest rates. When interest rates increase, capitalization or cap rates increase as well. Cap rates are the expected return on a real estate investment. Typically, cap rates are higher than interest rates, and this spread is called the risk premium. Which measures the demand for an asset with more risk than a treasury bond. The lower the cap rate, the higher the price you are paying for the property. This is why you will see premium A-class properties with low cap rates and old C-class properties with higher cap rates.
  • When cap rates increase, commercial property prices decrease. Suppose you purchase a property in a low-interest-rate environment and sell in a higher-interest-rate environment. In that case, you could sell the property for less than you initially expected. The shorter the hold, the more important the exit cap and interest rates are to your projections. The longer the hold, the less impactful the interest rate or cap rate is because you will usually add so much value to the property during that time. It is also very difficult to predict interest rates in 1 year, let alone 10 years, so it might not even be a factor you are figuring into your underwriting.
  • How do you protect yourself from interest rate increases, then? Purchase properties with a lot of meat on the bone. A past mentor of mine said to buy only fat deals—that is, properties with dramatically undervalued rents and lots of potential. When I coach real estate investors, I say that they need to buy properties that, when renovated, can actually raise rents by 25%+.
  • Investor Sentiment. Rising interest rates scare away potential real estate investors since many investors are worried about higher borrowing costs and possibly lower property values in the future, which makes perfect sense, especially if they are short-term investors.
  • Decreasing interest rates usually has the opposite effect, where investors are now more confident about lower borrowing costs and possibly higher future property values.
  • Rental Market Dynamics. When interest rates increase, some would-be homebuyers might continue to rent instead of purchase because they now might not be able to be approved for a mortgage. This usually leads to higher renter demand and possibly higher rental prices.
  • On the other hand, falling interest rates might make property ownership possible for renters who previously could not afford a home. Possibly lowering rental demand.
  • It is important to note that landlords who own class-A and class-B properties are more susceptible to losing tenants as they become homeowners. This will be less of an issue with class-C and class-D landlords since many C and D tenants lack the credit, cash, and or income to be approved for a mortgage.
  • Refinancing Opportunities and Hurdles. Property owners can decrease their debt servicing costs by refinancing when interest rates drop. If they have a prepayment penalty, the interest rate savings and the prepayment penalty must be considered first.
  • If interest rates increase, property owners who do not need to refinance will most likely avoid doing so; however, certain investors with loan terms ending during a higher-interest rate environment will now be forced to refinance, pay off the loan with their own funds, or sell.

The impact of interest rates on real estate investing can vary greatly depending on the individual investor’s strategy, time horizon, economic environment, and market conditions. Real estate investors need to consider all these points when investing.

Transcript:

Charles:
Have you ever wondered how a small tweak in interest rates can shake the real estate market? Let’s dive deep.

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo, and today we’re going to be discussing the impact of interest rate changes on real estate investing. So interest rates and the cost of debt are major factors when investing in real estate. Since in most situations, real estate investors fund most of their purchases with debt. Now, when interest rates change, these changes can significantly impact real estate investors in several ways. Number one, one of the most obvious changes is the cost of borrowing. When interest rates increase, real estate investors need to rework their investment underwriting within new cost of debt to see if the deal still makes sense. Now, this can be tricky with short-term holds because investors need to purchase the property initially and resell it at a profit in the future.

Charles:
If interest rates are increasing, they need to ensure that when their renovations are complete, the value has been added. The new buyer can actually obtain financing and purchase the property while compensating the seller to make it all worthwhile. Now, interest rates are still a factor with long-term holds. If the investor obtains long-term fixed rate financing, say 10 year or longer loan term, and the property is currently cash flowing or very close to it, with the current interest rates, this is a much lower risk investment. The investor now has 10 years to complete renovations, increase rents, correct property management, or anything else that’s going wrong. And then in 10 years, the property will most likely be valued much higher than it was when it was purchased. So it can be easily refinanced even if the interest rates are higher. Now, if interest rates drop, this is typically a benefit to the investor since in many interest rate decrease in situations, the value of rental property increases since real estate becomes a more attractive and sought after asset class.

Charles:
Two, property prices. So investment property values, especially commercial real estate values, correlate heavily with interest rates. When interest rates increase capitalization or cap rates increase as well. Now cap rates are the expected return on in real estate investment. Typically, cap rates are higher than interest rates, and the spread is called the risk premium, which measures the demand for an asset with more risk than a treasury bond or the risk free rate of return. Now, the lower the cap rate, the higher the price you’re paying for the property. This is why you’ll see premium A class properties with low cap rates and old C class properties with higher cap rates. When cap rates increase, commercial property de prices decrease. So suppose you purchase a property in a low interest rate environment, sell in a high interest rate environment. In that case, you could sell a property for less than you initially expected to. The shorter the whole, the more important the exit cap and interest rates are to your projections, the longer the whole and the less impactful the interest rate cap or cap rate is because you’ll, you’ll usually add so much value to the property during that time. And it’s also very difficult to predict interest rates in one year, let alone in 10 years. So it might not even be a factor you’re figuring into your underwriting.

Charles:
So how do you protect yourself from interest rate increases then? Well, purchasing properties with a lot of meat on the bone is the best way. Now, a past mentor of mine said to buy only fat deals. That is properties with dramatically undervalued rents and lots of potential. When I coach real estate investors, I say that they need to buy properties that when renovated can actually raise rents by 25% to 30%. I use a case study on when I am, hen I’m showing this in my coaching sessions and it shows a deal that went foreclosed and it shows that they were only raising rents by like 10%. There wasn’t any meat on the bone. They were literally just trying to grab a little bit of market share and highly leverage the property, and that’s why it went under three investor sentiment. So rising interest rates can usually scare away potential real estate investors. Since many investors are worried about higher borrowing costs and possibly lower property values in the future, which makes sense, especially if they’re short-term investors.

Charles:
Now, decreasing interest rates usually has the opposite effect, where investors are now more confident about lower borrowing costs and possibly higher future property values. Four is rental market dynamics. When interest rates increase, some would be home buyers might continue to rent instead of purchase because they might not be able to be approved for a mortgage now and now This usually leads to higher rental demand, higher rental prices. On the other hand, falling interest rates might make property ownership possible for renters who previously could not afford a home possibly lowering rental demand. Now, it’s important to note that landlords who own Class A and Class B properties are more susceptible to losing tenants as they become homeowners. This is less of an issue with Class C and Class D landlords. Since many c and d tenants lack the credit, cash, and or income to be approved for a mortgage in the first place.

Charles:
Five is refinancing opportunities and hurdles. So property owners can decrease their debt servicing costs by refinancing when interest rates drop. If they have a prepaying penalty, the interest rate savings and the prepaying penalty must be considered first before refinancing. If interest rates increase, property owners who do not need to refinance will most likely avoid doing so. However, certain investors with loan terms ending during a high interest rate environment will now be forced to refinance and pay the higher interest rate, pay off the loan with their own funds or sell the property. Now, the impact of interest rates and real estate investing can vary greatly depending on the individual investor’s strategy, the time horizon, economic environment, and the marketing conditions. Real estate investors need to consider all these points when investing. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

Links Mentioned In The Episode:

Are You a Fan? Subscribe, Rate, Review & Share – Click Here To Learn How

What question do you always wish I would ask but I never do?

Connect with the Global Investors Show, Charles Carillo and Harborside Partners:

Scroll to top