How to balance cash flow and high interest rates?

Question

I am a residential real estate investor who has always believed in the SFR market up to fourplex. Yes, I have started pivoting towards built-to-rent (BTR) in 2022 and going forward. Still, the main goal of my investing and that of my mentoring clients is cash flow to generate a passive income flow that ultimately leads to reaching the Time Freedom Point at which one has the choice to exchange time for money (JOB) or live your passion regardless if it makes any money.

In 2022 we have all seen the FED increasing interest rates and along with it, mortgage interest rates have gone up a lot.

I wonder what the BP community thinks about the future of interest rates, especially for financing our residential property investments and what you would do or accept regarding cash flow. In the past we used the 1% rule, which is increasingly hard to meet. For BTR, I am willing to accept performance above 0.8%, but what are you willing to accept and where do you think interest rates will be in 6 months, 12 months, and 18 months from now?

Just for those of you who wonder, I have toyed with interest-only loans or ARM financing, but so far haven't done it yet. Maybe you will comment on that too as part of what you're willing to accept to maintain cash flow/performance.

Axel Meierhoefer · Answer

I agree Alex. I have always hoped to find deals like that or work with experts who have more of these deals than they can handle themselves and then offer them to my tribe and myself. Maybe a wish for 2023 :-)

Carlos Ptriawan · Answer

This is a very smart answer.As folks gained experience they may realize what really drives the market. Experienced folks don't really need a Realtor as their investment advisor :)So what drives the appreciation are: job/economic growth and interest rate. This drives up the market. Since we experienced investors remember the amortization table on top of our heads, we're not afraid of IO products or ARM products. It's just like tools that we need to know when to use and where. For any mortgage product, there's a third component that's being forgotten and that's "time component". It's with an intricate understanding of all debt component, I can pay off 30 years loan in 10 years with the tenant paying the mortgage. It's for that reason that I keep leveraging in california and ignoring the cash-flow "advisor" in BP :) ... until recently and I started the reverse process.

Sam Yin · Answer

@Axel Meierhoefer

This is dependent on what stage an investor is in, what market, and what cashflow is acceptable to them. ARM and IO are all very viable options depending on the goals and skillsets of the investor. Experience is really the key.

Some investors may have their own personal rule never to go with those loan products.  Others always use those loan products. These types of products generate more cashflow.  For someone living off of investing,  that is really important.  It allows them to qualify for more/bigger deals.  For those that have a W2, they have different perspectives and needs from their investments.

Another factor is SFR or multifamily.  They provide different returns and stability in contrast to loan product.

I use to only believe in 15 yr PITI. then I evolved into 30 yr PITI.  As I moved into commercial multifamily,  I like 3 to 7 year balloons with 30 yr amortization.  Then as time went on, deals got bigger, and I gained experience, I like the IO balloon in 7 to 10 yrs.

I had always heard that full time mom and pop investors like IO. I did not fully understand why until about 6 months ago.  It's now my go to product for anything over 15 units and I'm willing to do that for over 10 units as well.  For context, I invest mainly in SoCal. If I invest in MO, IN, or AR, it would likely be over 40 units before I consider IO or ARM. This has to do with current housing market trends and historically low appreciation in those markets. That is key to survivability.

Just my .02

Carlos Ptriawan · Answer

ARM is eventually better than IO, but IO could be a good tool if you add principal every year and "structure the payment" following 3% amortization ( I did this). Even with 3% rate, the first few years the ratio of P:I is about 6:9 only.So if you purchase IO or ARM, but add principal every month, then it's not that bad actually.My biggest issue from my view is actually appreciation growth. This is the hard part.

Axel Meierhoefer · Answer

Carlos, main reason is that I don't know them and I follow a rule to only invest in things I understand

Alex Evans · Answer

We have seen a number of investors switch over to dscr loans or interest-only loans. It is a great option if you are strictly looking for cash flow.

Axel Meierhoefer · Answer

Yes, that's true and the refi-option is great. Not many other countries allow that. One of the issues investors can run in though si qualification. I have not seen cost of living calculations getting adjusted (although they should) but anybody using traditional instruments like FHA might have issues keeping enough room to afford the mortgage at increased interest rates

Sam Yin · Answer

Couldn't have said it better myself. 😎👍

Jack Mawer · Answer

With a fourplex you should be able to achieve cash flow even with the current rates - in addition, even if you took on a mortgage on a rental property in the current market, you will still be able to refinance in the near future when rates come down - I would not pass up an opportunity that makes sense as an Invesment just b/c of heightened rates.

Axel Meierhoefer · Answer

Thanks for sharing. Those are important points. I would add that the time horizon is equally critical. My tribe and I look at 8-10 years to reach the Time Freedom Point

How to balance cash flow and high interest rates?

Most Popular Reply