How to Buy Real Estate When Interest Rates Are High
The past year has been quite the roller coaster. Interest rates experienced an unprecedented rate of increase, which had potential home buyers and real estate investors really feeling the squeeze. Despite these challenges, real estate remains a powerful tool for building wealth.
Now that rates have seemingly leveled off somewhat (though they are still roughly double what they were just a few months ago) it's time to reassess and adjust our approach to funding real estate purchases.
Rather than waiting for rates to drop back down to levels we may never again see in our lifetime, there are several strategies we can be using to continue to add real estate assets to our portfolios.
Focus on Cash Flow
Cash flow is the lifeblood of real estate investment (an any investment for that matter). Without positive cash flow, you are left paying the bills out of your pocket. Negative cash flow for too long could mean the end of your investing career.
Most real estate investments are purchased using loans, which are paid back out of the property's cash flow. It only follows that when the cost of borrowing increases, the remaining cash flow left after paying the note is reduced.
Higher interest rates = Lower cash flow
That said, no matter the interest rate, every property - every single piece of property out there - has a price associated with it that makes it a solid investment. Unfortunately this number is commonly below the price the owner is willing to accept for the property. It is the investors job to find the properties where their target price matches the price the seller is willing to accept.
In times of high interest rates, this means the price an investor should be willing to pay will likely decrease, unless other factors like rising rents come into play.
Your goal as an investor is to find the properties you can purchase at the higher interest rates that still provide cash flow that meets your cash flow needs. That means finding properties priced below market value or that need some repairs or improvements to realize their true income potential.
This requires more discipline and a willingness to get creative with your strategies of finding properties (see another article on that subject here).
Also, times like these are a great time to explore creative financing strategies.
Get Creative with Financing
30-year mortgages are not your only option! Yes, they can be some of the cheapest money available for certain small properties, but these loans may not always be the best option.
In my experience, loans from smaller community banks have been extremely helpful. Yes, they typically come with a bit higher interest rate (but not always) and have shorter amortization (payback) periods, but they come with far fewer "strings" and headaches compared with conventional mortgages. I would strongly recommend any investor in small properties (epsecially small multifamily properties) look into this financing option.
Another creative financing method is seller financing - just bypass the bank all together.
If done correctly seller financing can help you find the ultimate win-win for buyer and seller. For example, in a market like we find ourselves currently (high interest rates and peaked property values) a seller is likely facing the prospect of discounting his or her property now that interest rates have priced out a lot of buyers. And you, the investor, are looking at a cash flow crunch after factoring higher interest rates into your financing.
What if I told you that both of you could have what you want if you are willing to give up a little bit and compromise? Seller financing can make that happen. With seller financing, everything becomes negotiable.
Seller is dead-set on a certain price? Well, if he's willing to give you a sweet deal on the interest rate when he finances the purchase to you, you can come up with a financing scheme that can justify his price. I know this from experience. Under the right financing terms, the price becomes secondary.
(Disclaimer: Please, please have an attorney review all documents related to a seller financed transaction. Banks have armies of attorneys draft their documents, which are subject to federal regulatory oversight. Seller financing is like the wild, wild west in that respect. Be sure you are prepared and understand what you are signing!)
Go Big with Commercial
Another strategy is to invest in commercial properties. Commercial properties, such as office buildings, shopping centers and apartment buildings (officially defined as five or more residential units), can generate higher levels of cash flow and higher returns than residential properties.
Yes, there are some additonal barriers to entry into the commercial space, but all are surmountable if you are willing to get creative and are flexible. Partnerships and your investment team are critical to your success in commercial investing. We will cover this topic more in a future post.
Wall Street instead of Main Street
strategy of adding real estate to your investment portfolio could be through a REIT (Real Estate Investment Trust). REITs allow you to invest in a diversified portfolio of properties, which can help spread risk.
REITs provide a way to invest in real estate passively, meaning you don't have to do anything except look at your account statements and count your money. This can certainly beneficial if you don't have the time or expertise to manage a property yourself.
Additionally, REITs can be traded on the stock market, which can provide liquidity and make it easier to buy and sell shares.
It is important to keep in mind that interest rates are just one factor affecting real estate investments. While high interest rates can make it more difficult to find profitable investments, they are not the only thing to consider. Other factors, such as the state of the economy (both local and national), the strength of the rental market, and the overall health of the real estate market, can also have a big impact on the success of your investment. It is important to do your research and evaluate all of these factors before making an investment.
In conclusion, investing in real estate when interest rates are high can be challenging, but it is still possible. There are a number of strategies that can help you find profitable investments, such as focusing on cash flow positive properties, finding creative means of financing, investing in commercial properties, and buying shares of REITs.
If you need any help finding or selling a home or investment property, reach out to Sally or check out SoldWithSalBR on Facebook. As always, if you have any questions relating to real estate, remodeling, Baton Rouge or life in general, drop us a line at firstname.lastname@example.org.