Is Real Estate A Good Investment When Interest Rates Are High?
Is Real Estate a Good Investment When Interest Rates Are High?
Leverage is one of the great things about real estate because it enables investors to use less of their own money and, as a result, see increased returns on their investments. That said, when interest rates are high, the cost of borrowing increases and can substantially impact those returns.
With interest rates at a 20-year high and, perhaps, still rising, many investors wonder whether real estate continues to be a good investment. To help answer that question, here are some advantages and disadvantages of investing during periods of high-interest rates and a look at effective strategies during such periods.
Changes in Rental Property & Real Estate Demand
When interest rates are high, there are two important changes in demand that positively impact investors. First, demand for rental units increases. As investors know all too well, when interest rates increase, so do mortgage rates. This makes it more expensive to buy a home and causes more renters to delay the purchase of their first home. The result is increased demand for rental units and decreased vacancy rates for Property Managers.
Plus, it’s important to note that the increased demand for rental units ensures that rent prices remain high. While rent prices have stabilized recently in many parts of the county, they have been rising substantially over the last two years – up 15% in 2021 and 6.2% in 2022. As interest rates tame inflation, prices will continue to stabilize, but investors can feel comfortable that the high demand for rentals will ensure that prices remain competitive.
Second, and closely related, demand in real estate markets decreases when the cost of borrowing increases. This results in less competition, lower prices, and more opportunities to buy real estate at a discount.
Both of these shifts are positive for investors and something to consider when thinking about buying in times when interest rates are high.
Increased Borrowing Costs & Decreased Purchase Prices
As we’ve already alluded to, the biggest impact for investors right now is that it’s more expensive to use leverage to purchase real estate. When interest rates are high, monthly mortgage payments are higher and cash flow is hurt. This can quickly eat away at profits and result in deals looking less attractive.
That said, in the current market conditions, investors are able to balance that additional expense with the opportunity to buy at lower prices, negotiate better terms, and acquire real estate at a discount. After a couple of years with lots of bidding wars, seller-friendly terms, and quickly rising home prices, markets have finally cooled some and given buyers a chance to negotiate favorable deals.
The takeaway here for investors is yes, the cost of borrowing is up, but there are also more opportunities to buy at a discount and create deals that will work even with higher rates.
Strategies for Buying During Periods With High-Interest Rates
For buy-and-hold investors, real estate continues to be a solid investment, even when interest rates are high. As you look to expand your portfolio, here are a few strategies to help you get the most out of the current market conditions.
- If you can buy during periods of high rates, do it. Try to find ways to put together deals with attractive terms – for example, cash or no contingency – so you’ll have opportunities to buy at a discount.
- Focus on your long-term strategy. If you’re a buy-and-hold investor, the real wealth building happens in the long term. Prioritize your long-term goals and properties that will help you meet those goals – even if it means less cash flow in the short term.
- Get creative with financing. Take advantage of short-term loans, adjusted-rate mortgages, and other borrowing tools that will allow you to purchase rentals now and make adjustments to terms in the future.
- Focus on all the wealth-building benefits of real estate. Cash flow is an important factor, but so are appreciation, tax benefits, and the opportunity to hedge against inflation. Keep all of these factors in mind when analyzing deals, and don’t be turned off by decreased cash flow in the short term.
That said, in all markets, it’s vital to effectively analyze a deal to make sure that it makes sense both in the long and short term. As you do, don’t let higher interest rates scare you off. Instead, focus on your long-term goals and be creative with financing and terms. If you can do this, you’ll be able to expand your portfolio and build wealth despite interest rate fluctuations.