Did you know that the United States is one of the few countries that offers a 30-year FIXED mortgage rate? Most countries offer adjustable, variable, flexible, or renegotiable rate mortgages, all of which pose an inherent risk with the potential of an unexpected interest rate hike during the ownership of the property.
Everyone understands now more than ever just how much of a huge financial benefit it was over the past 8-10 years to lock in historically low-interest rates, below 4%, but what happens when rates go back up to the historical average of 6-8%? Should you still invest in rental properties?
Dumb question, I know but one that needs to be discussed since the days of 3-4% interest rates are a thing of the past.
Decades from now I will be telling my grandchildren that when I was your age…
In order to answer that question, it is important to understand all of the factors that go into investing in real estate.
These are the 5 Pillars of real estate investing:
- Cash flow
- Tax benefits
- Equity built via mortgage paydown
- Hedging against inflation
You will notice that cash flow makes up only 20% of the equation…Yet these days, every investor seems to be fixated on cash flow only because we just went through a historic rise in interest rates over a short period of time.
Just keep in mind that cash flow is not the ONLY reason why you should invest in real estate.
Let’s explore why you would be short-sided to only factor in the cash flow equation when deciding if you should invest in a property:
Rents will increase for two reasons: appreciation and inflation. (Sounds familiar?)
Guess what doesn’t increase over time and is not affected by appreciation or inflation? Your FIXED mortgage payments.
This means your cash flow spread will continue to grow over the life of your rental property as you continue to increase rents.
However, I do not think it is wise to assume rents will just always continue to rise. Instead of hoping for rental increases, here are some things we do for our investors who purchase long-term assets from Property Rush:
- Buy in solid A & B class neighborhoods that tend to have high demand and will appreciate over the years.
- Improve the property: We do not fall for the rookie temptation to just paint over problems like most landlords do in order to save a buck in the short term. Our philosophy is rooted in long-term thinking. We think in terms of decades, not months. So make sure to put nicer finishes in the home upfront. Put in stainless steel appliances instead of white to match what is there. Go with butcher block or quartz countertops instead of laminate. LVP instead of carpet, replace the windows, don’t just put blinds on to cover them up, etc.
- Refinance your mortgage: Pay attention to the rates and remember, they fluctuate so over time what goes up, will come down eventually…Lock in a better rate when the time is right and your cash flow could drastically improve.
SPOILER ALERT…If you are a Dave Ramsey disciple do not continue reading…
You should NOT buy an investment home with cash (unless we are talking about a 1031 exchange scenario)… Here is why:
You pay back the 30-year loan in YESTERDAY’S dollars, not TOMORROW’S…The dollar loses value EVERY SINGLE YEAR…In 10 years, imagine how much money you will need to earn just to maintain the lifestyle you have today…It is staggering to think that if you make less than $100,000 in 2023, you will struggle to make ends meet. That number will only go up over time.
Look at inflation as compared to the interest rate of the mortgage. Many experts argue that the mortgage interest you pay over the term of a 30-year fixed mortgage is less than the expense of paying for the same property in cash with today’s dollars because of inflation.
When the inflation rate is higher than the interest rate on your mortgage, your profits will continue to outrun the expense of that mortgage.
Bottom line…Do not FIXATE on interest rates and cash flow when making a decision about investing in a rental property. There is so much more to consider…Although, we will always factor in the cash flow at today’s interest rates to ensure there is cash flow for our investors in year one… It is incredibly important that you think of the bigger picture when investing in real estate.
“Seek wealth, not money or status. Wealth is having assets that earn while you sleep.
Jeff Bezos: “All overnight success takes about 10 years.”
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