Summary: If you’re a real estate investor or you’re thinking about becoming one, rising interest rates have probably weighed heavily on your mind. You’ve probably asked yourself, “is this a good time to invest?” “Should I wait until interest rates go down?” In this article, we’ll give you our perspectives based on over 20 years of real estate investing experience, including investing through three downturns!
[Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
If you’re new to investing or even if you’re an experienced investor, you’ve probably asked yourself, “with rising interest rates, is this a good time to invest?”
It’s probably one of the most common questions we get from new investors as well as members of our community.
You might be surprised to learn, we’re not worried!
In this article, we’re going to explain why.
Before we dive in, we need to start with a few definitions. People throw around the terms “interest rate” and “mortgage rates” as if they are synonymous. They’re not.
First know the difference between interest rates and mortgage rates
Many don’t know the difference between interest rates and mortgage rates.
When you hear about interest rates going up in the news, this usually refers to the Federal Funds rate, which is the interest rates that banks charge to each other. This is something the Federal Reserve either raises or lowers depending on what’s happening with the economy.
Currently, with inflation out of control, the Federal Reserve is raising the Federal Funds rate to try to tame inflation.
A mortgage rate is what banks charge you to borrow money to purchase a property. Over the past year, mortgage rates have gone up as a result of inflation. Many think that mortgage rates are going up because the Fed keeps increasing interest rates. However, the relationship between the Fed’s actions and mortgage rates isn’t direct.
Now that we know the difference between interest rates and mortgage rates, for the rest of this article, we’re going to focus on rising mortgage rates. Let’s start out by looking at what mortgage rates do to your cashflow.
What is the impact of rising mortgage rates on cashflow?
If you’ve been following us, you know that we only buy properties that cashflow. Otherwise, you’re buying a liability.
When mortgage rates go up, this increases your monthly mortgage payment. As a result, your expenses go up. When your expenses go up, assuming your rental revenue and other expenses stay the same, your cashflow goes down.
[This is easiest to see when you plug in numbers into a cash-on-cash calculator. If you don’t have one handy, you can download ours below.]
All you do in the calculator is increase the mortgage rate, but keep all of the other variables the same. When you do that, you’ll see that the cashflow and cash-on-cash return drops.
So you might be wondering, “if mortgage rates cause my cashflow to go down, shouldn’t I lower my standards or wait to invest until interest rates go down?”
How to maintain cashflow when mortgage rates go up
When mortgage rates go up, many have this knee-jerk reaction to either compromise on their criteria or to sit on the sidelines.
But what if you could maintain the same level of cashflow with rising mortgage rates?
This is what we do. We don’t compromise on our criteria. The criteria stays the same even when borrowing costs go up.
How do we do that?
We do that by changing other variables in our calculator.
One thing we do is lower the purchase price. We know how to buy properties at a discount, even when the real estate market is hot. Now that the market has cooled, it should be even easier to be able to buy properties for considerably less than asking.
The other thing we do is find ways to significantly increase our revenue. Most people assume there’s a ceiling on rent. The problem is, they’re only thinking about one type of customer. What if you went out and found a higher paying customer?
We and many others in our community have done this successfully with supported living, rent by the room, Section 8, mid-term rentals, and short-term rentals.
One last thing you could explore are ways to decrease expenses. Maybe you lower utility costs by installing energy efficient lighting, faucets or toilets. Maybe you negotiate down property management fees. Maybe you self-manage. These are all things that we have done over the years to lower our expenses.
Bottom line, there’s no reason to compromise on your buying criteria just because mortgage rates are rising.
So before you decide to sit on the sidelines and wait for mortgage rates to come down, below are a few other things to consider.
Mortgage rates are still low historically
For those who haven’t been investing very long, the rising rates are like a jolt to the system. It’s probably scary for many to see interest rates of 7% when you’re used to interest rates in the 3-4% range.
Well if you’ve been investing in real estate for the last two decades like I have and you had parents who invested back in the 1980s, 7% isn’t bad at all.
If you look at the chart below, you can see that interest rates are back to 2001 levels, which is what they were when I started investing.
If you go even further back to the 1980s, you see that interest rates were between 10-18%!
Do you think that stopped people from investing? No, in fact, many of the people who invested back then grew their wealth significantly!
If mortgage rates go up, prices will come down
While it’s hard to know exactly what will happen to prices when mortgage rates go up, it’s thought that home prices will come down.
One of the main reasons is, when borrowing costs go up, this is a deterrent for buyers so demand for housing goes down.
With lower demand, prices have to come down.
We are already seeing the impact of higher mortgage rates on buyer behavior. It doesn’t look like sellers have lowered their expectations just yet but this is also starting to change.
We believe that in the coming months, there will be even greater opportunities to negotiate lower prices as sellers realize that they are no longer in the driver’s seat when it comes to pricing.
You can always refinance
Nobody can predict the future.
Some believe that mortgage rates are going to continue to rise. Some believe that mortgage rates are going to go down as the Fed tames inflation.
Let’s examine both scenarios.
If mortgage rates rise, the current 7% mortgage rate is going to seem low and you’re going to be glad you locked in a good rate.
If mortgage rates go down, you can refinance. When that happens, because you didn’t compromise on your criteria, your cash-on-cash return is going to be even better at the lower mortgage rate!
So either way, as long as you stick to your criteria, you can do well in any economy!
Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD Facebook page and join our Physicians (for MDs or DOs only) or Professionals group!
Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.
