What should that do to YOUR calculations, as far as overall rate of return? Here's an example: On a deal I'm underwriting, it takes about 1.1 percentage points off the average 5-year Cash on Cash return for the property (constant purchase price). From 11.4% to 10.3%.
Here's where it gets interesting: If I want to preserve the 11.4% cash flow, all I have to do is get the seller to accept a 3% lower selling price than I'd originally bargained for. (That also keeps my investors' target IRR about 20% over a 5-year hold...my goal is for each investor to double his/her investment in that period.)
So, you can see what higher rates are going to do to prices: For every half-point increase in rates, we'll need to see a 3% drop in purchase price. (Says my spreadsheet. What does YOURS say?)
If you're in contract on a deal you got under contract before Nov. 8, are you going to try to "retrade" the purchase price by 3% to account for the rise in rates? If the Seller voted for Mr. Trump, then I think he/she should share in the pain!
Buy-and-Hold Rental Investor · Santa Fe, NM · Member since 2015 · 438 posts · 352 votes
9y
And we're not even accounting for a selling cap rate that is 1-2 points higher than what you bought it for...for me, a 1 point increase in selling cap trims the investors IRR by 5 percentage points. YIKES! Yet I look at all these PPM's for multifamily group investments on www.crowdstreet.com and others and they all seem to assume selling at the same or lower cap rate 5-10 years out. REALLY? Is that a conservative outlook that demonstrates the sponsor's fiduciary responsibility to the passive investors?
Investor · Anaheim, CA · Member since 2014 · 242 posts · 81 votes
9y
Regarding your IRR calculation, what was the total acquisition cost and were extra funds contributed over the 5 years period? I'm just trying to check my irr math in comparison to c.o.c.
Buy-and-Hold Rental Investor · Santa Fe, NM · Member since 2015 · 438 posts · 352 votes
9y
Greg S. - Sort of. At some price and interest rate, the property doesn't meet the bank's Debt Coverage Ratio of 1.25. The deal will fail then unless the seller agrees to a retrade or the buyer puts in more equity. A seller needs to be realistic to changing market conditions, no?
Marc C.
Real Estate Agent · Austin, TX · Member since 2014 · 636 posts · 486 votes
9y
I see your point, and the math checks out; historical precedent does not, however. Historically, interest rates have a small effect on the housing market. You definitely need to factor those costs in, but the added debt-service cost to the buyer is not 100% offset by the price. If you can use this logic to get the seller to drop their price, by all means, use it, but I think in most situations you're not going to get your hoped-for 3% reduction.
I see your point, and the math checks out; historical precedent does not, however. Historically, interest rates have a small effect on the housing market. You definitely need to factor those costs in, but the added debt-service cost to the buyer is not 100% offset by the price. If you can use this logic to get the seller to drop their price, by all means, use it, but I think in most situations you're not going to get your hoped-for 3% reduction.
I agree to an extent. Small variations in interest rates won't effect things much. However if we were to see a doubling of interest rates from their current levels, it would hit buyers hard.
A 500,000 loan at 4.25% interest and 20 year amortization equates to a $3096 monthly payment. The same loan at 8.5% interest equates to a $4339 monthly payment. Sellers would probably be forced to either drop their prices, or perform more alternative financing deals like subject-to or owner financing.
Real Estate Agent · Austin, TX · Member since 2014 · 636 posts · 486 votes
9y
@Anthony Gayden, I'm not saying it's logical; I'm just saying that historically the interest rates and the sales price are not very closely related. Just look at the early 80's in the US. My parents bought their house at a whopping 16% interest rate in '82. Thank God that's over, but they didn't get the insane discount that you would expect. There are lots of more important factors that influence price, so to expect a 1-1 trade off will just lead to disappointment for the OP.
Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
9y
For buy-and-hold scenarios where cashflow is king, you should not simply take the higher rate and not question it.
You should buy the rate down until it's right back where it was, or until you start to hit diminishing returns.
Rates have gone up, while rate buydowns have actually gotten a little better for many scenarios.
I was defaulting to "no points" for years and then asking the borrower for their thoughts (because there is no one size fits all), now I'm defaulting to the above and asking the borrower for their thoughts (because there is still no one size fits all -- maybe that $3000 in points will lower their P&I by $45/month, but using that same $3,000 to improve a kitchen will let the unit command $75/month more in rent).
Rental Property Investor · Charlottesville, VA · Member since 2012 · 1k+ posts · 726 votes
9y
@Marc C. Have you been actually quoted a higher interest rate on a deal or are you just speculating? I am asking because I was surprised to hear a commercial lender I am working with has not budged on the rate I was getting pre-election.
What should that do to YOUR calculations, as far as overall rate of return? Here's an example: On a deal I'm underwriting, it takes about 1.1 percentage points off the average 5-year Cash on Cash return for the property (constant purchase price). From 11.4% to 10.3%.
Here's where it gets interesting: If I want to preserve the 11.4% cash flow, all I have to do is get the seller to accept a 3% lower selling price than I'd originally bargained for. (That also keeps my investors' target IRR about 20% over a 5-year hold...my goal is for each investor to double his/her investment in that period.)
So, you can see what higher rates are going to do to prices: For every half-point increase in rates, we'll need to see a 3% drop in purchase price. (Says my spreadsheet. What does YOURS say?)
If you're in contract on a deal you got under contract before Nov. 8, are you going to try to "retrade" the purchase price by 3% to account for the rise in rates? If the Seller voted for Mr. Trump, then I think he/she should share in the pain!
I don't think you could be this misinformed. The man isn't even president yet, and you are already spouting "under Trump". I would say the earliest someone could conceivably even state that rhetoric would be 2-3 years into his presidency, due to carry over/trickle from Obama's 8 years in office.
Rental Property Investor · Friendswood, TX · Member since 2010 · 663 posts · 508 votes
9y
@Marc C. I didn't check your numbers but i think its important for people to really watch this......... I think it will reflect poorly on the buyer using this as a basis for a retrade. In theory one could be buying deals cash and the CoC would not be effected ( while i know financing is typical for syndication deals ).
Keep the interest rate increase risk projected....... and make sure the deals check out
Buy-and-Hold Rental Investor · Santa Fe, NM · Member since 2015 · 438 posts · 352 votes
9y
Jeff K: Just tracking the rates listed at the site I mentioned. Few sites post apt. rates.
I've already lost a SFR buyer because she couldn't qualify after the .5% rate increase on the residential side. But, as the other posters said, it is technically the buyer's problem. Except the house was tied up for a long time and ultimately didn't sell...which makes it MY problem. Which was my original point. Sellers can't deny things have changed.
As to the Trump Effect, no you can't blame him or anyone. But how does one deny the stock market craziness and the resulting bond market declines since the election? Can't pretend it didn't happen. What if it continues? Makes bonds less attractive, and, ultimately, real estate. Very basic economics.
Enjoying the discussion! Keep it up!
Investor · Salisbury, NC · Member since 2014 · 313 posts · 385 votes
9y
The market prices in the future expectations. Once Trump was elected the expectations of the future growth and inflation turned on a dime. That is why interest rates rose and the Libor rates have risen almost everyday since the election. The expectations of Trump's policy is being baked into current interest rates and the stock market.
@Anthony Gayden, I'm not saying it's logical; I'm just saying that historically the interest rates and the sales price are not very closely related. Just look at the early 80's in the US. My parents bought their house at a whopping 16% interest rate in '82. Thank God that's over, but they didn't get the insane discount that you would expect. There are lots of more important factors that influence price, so to expect a 1-1 trade off will just lead to disappointment for the OP.
My parents bought their first home in the early 1980's as well. Interest rates were sky high, but my parents used owner financing to get a good deal.
I've already lost a SFR buyer because she couldn't qualify after the .5% rate increase on the residential side. But, as the other posters said, it is technically the buyer's problem. Except the house was tied up for a long time and ultimately didn't sell...which makes it MY problem. Which was my original point. Sellers can't deny things have changed.
Lurkers: There's no 100% protection against poor lender practices, but to reduce the probability of this I'd suggest looking at the date on the preapproval letter. If it's old, ask for an updated one. If you want to do a little extra due diligence, ask for the AUS findings with SSN/DOB/FICO blacked out, but name and interest rate still visible. By now, any decent listing agent should know a pre-Trump rate from a post-Trump rate at a glance (hint hint: 3.375% ain't happening any more except in the world of online mortgage advertising).
As a lender, this little extra work to generate an updated offer-specific AUS does not bother me. It makes me go "oh, dang, that's a smart listing agent with their ducks in a row... I need to do my job really well to get a shot at earning their referral business!" -- there are far worse things for you as a seller than a lender that wants to make your agent happy.