Are rising interest rates a hindrance or a hidden opportunity for savvy real estate investors? In a financial landscape where rising interest rates can trigger unease, it's vital to grasp that the real estate market possesses its own distinct dynamics.
In this article, we'll explore the facets of investing in real estate during times of high interest rates, shedding light on the untapped potential that lies within this seemingly challenging terrain. Despite market fluctuations and the allure of alternative investments, one constant remains: the enduring need for housing.
Even when conditions aren't ideal, there will always be individuals seeking a place to call home, whether through rental properties or other real estate avenues. Read on for three tips you can reference if you’re looking to invest during a time of interest rate hikes.
How Does High-Interest Impact Real Estate?
When the federal reserve increases rates, the market has a huge impact. Buying property gets more expensive. Therefore the overall demand decreases for buyers who may have been looking previously.
More buyers are priced out
Long-term impact depends on the growth of the overall economy
This means their pre-approval amounts decrease, and any buying power they thought they had is diminished. As a result, buyers must use more of their savings to account for the increase or forgo homebuying altogether.
With a rise in mortgage rates also comes a rise in people looking to rent out homes because they have limited options.
The demand for homes is lower when interest rates rise, which is what the federal reserve wants to happen. To maintain a stable market, increase affordability, and have lower interest rates in the long run, the Fed has to increase rates from time to time.
So what does this mean for buyers and investors? With less demand for homes, investors may be wary of stepping into the real estate market, and buyers must either pay the price or wait until the federal funds rate goes down and the market is more favorable.
The supply of homes can also face restrictions as homeowners are hesitant to sell because doing so would mean entering the market as buyers in a higher rate environment, which could significantly increase their borrowing costs. According to a recent Redfin report, about 80% of homeowners with mortgages currently enjoy interest rates below 5%. With rates now hovering between 7-8%, more sellers are choosing to stay put. As a result, active buyers are left with a dwindling inventory to select from.
Long-term Impact Depends on Growth of Overall Economy
The lasting effects of high-interest rates on the real estate market depend on the overall performance and growth of the economy. As the economy stabilizes or expands, the dynamics of the real estate market may evolve, potentially creating new investment opportunities in this challenging landscape.
3 Tips for Investing in Real Estate in High-Interest Times
So, you want to invest in real estate despite market volatility? This certainly isn’t impossible, and you may be able to find success using some of these tips to inform your investment strategy.
Buy if you can
Consider a long-term strategy
Utilize ARM and short-term loans
Buy If You Can
Higher interest rates will result in higher borrowing costs. This will price many buyers out of the market and result in less demand, and possibly lower prices. It could be a worthwhile investment if you can afford to purchase a property during a time of high interest rates. Many home sellers will be trying to get their homes off of the market with no luck due to the lower demand. If you have the funds available, you may be able to negotiate a lower asking price by making a competitive offer (ex: cash, no contingencies).
You can also consider increasing your down payment amount. A higher down payment means less risk for the lender, this will help you secure a lower interest rate and avoid paying private mortgage insurance, which will lower your monthly payment and save you on interest in the long-run.
One factor that will always remain true, even during tough market times, is that people will always need a place to live and property values have historically bounced back and increased after economic downturns.
Consider a Long-Term Strategy
Compared to last year, American homebuyers have seen a 24% decrease in their spending power, as interest rates surpass 7%. With market volatility making buying difficult, many people will opt for renting because it’s what they can afford. As an investor, this presents a unique opportunity for you.
Borrowing money becomes more expensive when the Fed raises rates, and the demand for rental homes and apartments will increase as many prospective homebuyers will struggle to qualify for a mortgage, and will need to resort back to renting. A rental property in the right neighborhood can be a great investment that can increase in value overtime and help you hedge against inflation.
Purchasing a rental property can allow you to yield high returns, especially if you decide on a long-term strategy. According to a recent report from RentHop, a long-term rental strategy is more profitable for landlords that own 1–3-bedroom units in major cities with higher long-term rents such as New York City, Miami, and Los Angeles.
Investing in a home or apartment can help you take advantage of the current increased rental demand. However, you could also consider investing in commercial real estate, like duplexes and multifamily lots.
In South Florida, we have seen increased interest from both domestic and international investors towards investing in multifamily projects, particularly in affordable neighborhoods so they can obtain guaranteed rates through Section 8 programs and help satisfy the need for affordable housing.
Take Advantage of ARM and Short-Term Loans
You might also want to consider financing options like an adjustable-rate mortgage. An adjustable-rate mortgage (ARM) has a variable interest rate. Variable interest rate fluctuate over time and is based on a benchmark interest rate or index.
With an ARM loan, the starting interest rate will fall below the market rate, and will be fixed for a set period of time. After that fixed-rate period, the rate will float and adjust on a routine basis based on the current market rate.
As a real estate investor, an ARM loan can be a great option if you want to secure a lower interest rate for a fixed period of time, and gain some predictability with your payments. This is especially lucrative for investors with a short-term fix and flip strategy, as you aim to sell the property before the fixed-rate period ends. You can also use an ARM loan towards a long-term strategy and refinance the loan for a fixed rate mortgage in a few years, once interest rates cool down.
Below are some examples of adjustable-rate mortgages
Hybrid ARMs. A hybrid adjustable-rate mortgage, also referred to as a fixed period adjustable-rate mortgage, is a combination of a fixed-rate mortgage and an adjustable-rate mortgage. After the fixed interest period, the interest rate shifts to adjustable. The most common hybrid ARM is 5/1, which means five years fixed and then an adjustable rate that resets yearly.
Interest-only ARMs. An interest-only ARM is an adjustable mortgage where you’d only have to make interest payments for the first period of the loan, so you wouldn’t need to pay down the principal until later. Interest-only payments can be for a fixed time or the loan's entire life. The latter means you’d pay your principal in one lump sum at the end. Please note you aren’t building equity during the interest-only period, so your payments will increase when it’s over.
Payment option ARMs. A payment option ARM provides the buyer with several payment options to choose from, such as a 30 or 40-year amortizing payment, an interest-only payment, or a minimum payment, among other options.
You can also take advantage of a short-term loan from a portfolio lender, commonly known as bridge loans. A bridge loan can be used as a short-term solution to finance your investment property as quickly as a cash offer. The application process for a bridge loan is streamlined and requires minimal documentation, allowing you to receive funding in less than 10 days.
Rates for a bridge loan are currently ranging between 9% - 12% and can be fixed or variable. These are interest only loans, with a balloon payment due at maturity. This is a viable option for real estate investors who want fast access to capital and a lower monthly payment to keep expenses low until they transition to a long-term solution.
Bridge loans are short-term loans ranging from 1-3 years. As an investor, if you decide to use a bridge loan, it’s important that you have an exit strategy in place, so you have a plan on how to pay off the loan at maturity. Common exit strategies include:
Refinancing the loan
Selling the property
Using income from other ventures to payoff the loan
With so many financing options available, you can still invest in real estate during times of high inflation. You just need to have an investment strategy and align yourself with local real estate and mortgage professionals that can help set you up for the long haul.
Are you considering investing during high-interest times? You could have some luck here and achieve a significant return with the proper approach. As mentioned previously, high interest rates are not necessarily a reason to step out of the market. Interest rate hikes can allow investors to take advantage of having less buyers in the market and increased demand for rentals.
A rising rate environment doesn’t need to slow you down. People will always need housing, and even as we approach an economic downturn, real estate has historically bounced back and increased in value overtime.
How Vaster Can Help
So whether you’re looking to close on your next investment property via financing or are interested in learning about commercial loans so you can invest in a multifamily lot, we’re here to help.