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Everyone is talking about record-low interest rates these days. Freddie Mac reported earlier this month that the average 30-year fixed-rate hit a low of 2.88%. That's a 50-year record! And, there is still the possibility of rates moving lower in the coming months and years.
Real estate investors should be positioning themselves to take advantage of the current environment to better position their businesses amidst market uncertainty. Beyond the standard refinance advice, there are several other tactics investors should deploy: portfolio-wide analysis, stress testing, and understanding and leveraging supply and demand.
Here's an overview of where we're at with interest rates and what real estate investors should do about the low-interest-rate environment we find ourselves in.
With interest rates at historic lows, now is the time to conduct a portfolio-wide analysis of all your loans, the interest rates as well as the terms and conditions. Here are a few considerations as you conduct your analysis:
When does your mortgage come up for renewal, or when will the interest rate change in the case of an adjustable-rate mortgage (ARM)? If you are close to a period where you need to renew, it might be worth exploring with your broker your options now given the low rates.
Fixed vs. adjustable-rate mortgage (ARM)
Depending on the interest rate spread, you will need to consider one over the other. At the moment, there isn't a significant difference between these two types of mortgages in terms of rates, so a fixed rate is more appealing as it gives you more certainty and you can adjust the length of your loan more easily.
Do you pull out equity upon refinance to redeploy elsewhere? Given that housing prices are at historic highs, it would be a good idea to not overleverage your real estate assets so that you can weather any forthcoming economic downturn in housing. Already we are seeing a move from urban centers to less populated areas, meaning landlords in those cities will have a smaller renter pool and decreased rental rates. For investors who are overleveraged, they have less cash flow and less of a buffer to withstand extended vacancy. Be cautious; don't put yourself in this position.
The rate you have is also important. Generally speaking, if you can get a rate of at least 100 basis points lower than your current rate, it makes sense to break a mortgage and lock in a new rate. That said, run the numbers in your pro forma, and be sure that this new mortgage and rate fulfill your investment criteria.
Most of us invest in real estate for the long-term certainty of this asset class, not because we want to get rich quick. Buy-and-hold investing is a tried and tested method of wealth creation over the long term.
But, how can you ensure that what you have today will still make sense five years from now? One of the ways is to stress test. I offer two critical tests all investors should run across all their properties:
- Interest rate stress test: Using your pro forma, develop at least five scenarios that see interest rates rising 20%, 30%, 50%, 75%, and 100%. This will give you a sense of what your cash flow will look like if we do see a future spike in interest rates. Keep in mind that it's not that long ago that interest rates were two to five times what they are now.
- Vacancy stress test: We should all have a vacancy buffer in our pro formas. I personally use 10%. But what if vacancy all of a sudden hits 20% or even 50%? You should know what your property's break-even point is should the worst economic scenarios play out in the future.
Understand supply and demand
We have three critical phenomena happening at the moment: low supply, low rates, and high demand. This reality is driving up prices in housing, meaning investors can lock in profits by selling or refinancing, but it also means acquisition is more difficult as you may end up overpaying.
Look at different types of deals such as land acquisition and development. In this type of real estate deal, you can better control the costs and final price of the asset. Think long and hard before buying a resale property in a market that is at historic highs in terms of price and where bidding wars are rampant.
The bottom line
A low-interest-rate environment can be a boon for real estate investors if they position themselves and their portfolios in the right way. Low rates also have some drawbacks that investors need to be mindful of, particularly that it drives up demand and creates more opportunities for investors to overleverage themselves.
Conduct a portfolio-wide analysis of your current mortgages, don't overleverage yourself, stress test all your rental properties, and never overpay for a real estate asset. Follow these guidelines, and navigating our current low-interest-rate environment can be very lucrative.
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