Rates are certainly substantial, but definitely not the end-all, be-all especially when it comes to investing in real estate. There’s more to the picture that can significantly impact the success or failure of your investment.
In this two-part blog post, we’ll discuss the reasons why rates matter much less and zero in on what you should prioritize instead.
Let the Market, Not Financing, Drive Your Real Estate Decisions
A common saying about real estate encapsulates the best time to invest: “The best time was yesterday. The next best time is today.”
Interest rates wield a significant influence on real estate market demand. Low rates, as observed over the past two years, have spurred a buying spree, inflating real estate prices marketwide. In such scenarios, where multiple offers flood each property listing and often sell above asking price, identifying worthwhile investment opportunities becomes challenging.
However, this trend is changing. As higher rates have started to stabilize the market, discerning investors can see beyond financing costs and are open to promising opportunities. These investors are now witnessing an increased capitalization rate that promises to grow concurrently with time. The average annual rental rates have surged by 12%, with some markets experiencing a 40% rise during the COVID pandemic. The increasing pool of renters, against a backdrop of declining home buyers owing to affordability issues, coupled with a shortage of about 3.8 million houses in the U.S. (according to Freddie Mac) and supply chain disruptions have ignited higher demands for rental homes.
Integrating these factors with a decrease in property prices sets the stage for a higher capitalization rate. The same properties that once offered a 6% to 8% annual return now have the potential to deliver up to a 10% to 12% return. This scenario empowers investors to maintain a positive cash flow, even in a high-rate climate.
Inflation: A Frenemy to Your Investments?
With annual inflation rates shooting up to a startling 9.1%, investors are understandably anxious. Simply put, your money is losing 9% in value while sitting in your savings account. Here’s where real estate emerges as a hedge against inflation, offering a time-tested source of capital preservation and income generation.
You might, however, recall the earlier mention of an impending market cooldown. Granted, that’s a likely direction, but residential real estate has a unique advantage – unlike stocks whose valuation moves in response to market fluctuations, residential properties can yield consistent or sometimes higher income, even when the market value is sloping downward.
This is because the value of residential rental properties – as opposed to commercial properties – does not hinge on the income it produces. Consequently, when property prices shift, rents remain stable or even increase. Rent prices and property prices are influenced by different variables; renters seldom demand price reductions just because housing prices have plummeted.
In a nutshell, although inflation can erode your capital and buying power, real estate stands firm as a reliable safeguard. Therefore, in assessing financing rates, consider the “loss” you are potentially averting by safeguarding your capital via property investment.
Invest in the Long Term, Not Just Current Rates
Boosting your cash on cash return can be an exciting opportunity when the time is right. Imagine you’re using a loan to help with your investments and interest rates drop within a year. Here, you have the chance to replace your old loan with a new, lower-rate loan — a big perk of a 30-year fixed loan.
Smart investors often use this tactic in a market downturn to snap up properties when there’s less competition. They know they can replace their existing loans at lower rates later. This strategy lets them enjoy a good deal now while reducing their costs over time. Experienced investors often say, “When others were unsure, I stepped up and grabbed the opportunity…”
Yes, taking a loan when rates are high may cost more initially, but if you manage to secure a great deal, the overall return could be much higher and cover these starting costs.
One thing to keep in mind though is that replacing a loan does come with its costs and maybe even an early repayment fee (based on your loan agreement). Here are GL&L Holdings, we don’t charge prepayment penalties but other lenders may do. So, it’s essential to check if it’s worth it before starting the process. As investors, it’s important to consider this when getting a loan – a short or no early repayment penalty often means more financial freedom in the future.
Secure Your Investment Value
Economic reports suggest a looming dip in property prices, providing investors with a potential strategy – capitalizing on their properties’ peak value. Admittedly, executing this move may cost more than it would have a year ago, but higher property values present the opportunity to draw out higher cash-out value. This extracted cash can then be utilized to generate additional income, bracing for the anticipated market downturn.
An important note if you already have an existing loan on your property at a favorable rate- replacing your existing loan with a higher rate loan should only be done if you use the cash to acquire another income-generating property.
Improving Your Cashflow with Tax Deductions
Establishing a successful real estate investment portfolio is often more rewarding in the U.S. than it does in many other global markets, largely due to the country’s generous tax deductibility policy. The ability to deduct a wide variety of expenses — particularly when investments are made with financing — can significantly lighten the financial burden come tax time.
Every investor is subject to a unique tax circumstance, and therefore, it’s crucial to enlist the expertise of a certified public accountant (CPA) for personalized advice. Being able to deduct either all or a large portion of expenditures associated with a loan — such as interest over the loan’s lifetime — can bring invaluable financial advantages for the majority of investors.
When assessing a property’s prospective yield in comparison to its associated cost, investors are strongly encouraged to consult a CPA. This step will help to ascertain the true financial implications, including costs and benefits, ensuring that any decisions made are informed and financially sustainable.
Conclusion
Choosing a lending partner should be more than just the rates. Making investment decisions based on the current market, your long-term goals, and well thought out strategies are vital in achieving success.
Keep an eye for the next part of this blog! We’ll uncover more insights about rates and investment strategies.
If you’re interested in a loan or would like more information on this topic, consider getting in touch with GL&L Holdings! We’re here to guide you in your investment decisions and help you succeed.
[Disclaimer: This post and strategies included herein are not to be taken as investment advice. Always acknowledge the risks and rewards associated with every investment. Consult a professional financial advisor to inform and guide your decisions.]
