1996 rates were higher and deals worked. Where do the numbers stop making sense?

Question

Rates were higher in 1996 and deals still penciled. Where do the numbers stop making sense today?

We keep hearing "7% is historically normal, quit complaining." That's true. The 30-year averaged about 7.8% in 1996, and it's 6.95% this week.

• In 1996 the median house (year I bought my first house) cost roughly $116k against a median household income around $35k, which is about 3.3x income.
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• Today it's $429k against roughly $84k, or about 5.1x. Same rates, very different math.

In 1996 the median house (year I bought my first house) cost roughly $116k against a median household income around $35k, which is about 3.3x income.

Today it's $429k against roughly $84k, or about 5.1x. Same rates, very different math.

For investors, the way I look at it: a 30-year loan at 6.95% costs about 7.9% of the balance per year in P&I. If you're buying at a 5.5–6% cap rate, leverage is working against your cash flow from day one. In the 90s you could borrow at 8% and buy at a 10 cap. Now you borrow at 7 and buy at a 6.

So, a few questions for the group:

• For those who were investing in the 90s, what did a typical deal look like (price, rent, rate, cash-on-cash)? Was positive leverage as common as I think it was?
• What's your walk-away line today? A minimum cap rate, a DSCR floor, a rent-to-price ratio?
• If you're buying with negative leverage right now, what's the thesis: rent growth, appreciation, a refi when rates drop? What happens if rates stay here for five years?
• Which gives first, prices, rates or rents? Inventory just hit 4.9 months, the highest in over a decade, and prices are only up 1.6% year over year.
• Which markets or asset types still clear the loan constant without heroic assumptions?

For those who were investing in the 90s, what did a typical deal look like (price, rent, rate, cash-on-cash)? Was positive leverage as common as I think it was?

What's your walk-away line today? A minimum cap rate, a DSCR floor, a rent-to-price ratio?

If you're buying with negative leverage right now, what's the thesis: rent growth, appreciation, a refi when rates drop? What happens if rates stay here for five years?

Which gives first, prices, rates or rents? Inventory just hit 4.9 months, the highest in over a decade, and prices are only up 1.6% year over year.

Which markets or asset types still clear the loan constant without heroic assumptions?

Not calling a top or a crash. I'm trying to find out where experienced people draw the line.

Jay Hinrichs · Answer

I was only doing buy low sell high and rent as last resort so never really dove into the numbers.. but growing up and starting my career in the SF Bay Area nothing ever cash flowed with minimum down payments. Also I suspect this is very regional the 429k number is quite skewed when you add in high price markets like NYC Wa DC Bos SF LA San Jose etc etc.. you go to the mid west and median home price in many cities is still well under 300k.. It really depends on the market .. And this is why Cash flow investors from out of state tend to flood to the mid west from the deep south up through Memphis KC ST any town Ohio etc etc.

John Leland · Answer

I had just committed to a couple of large projects in August of 2001 expecting to close in mid September when the Twin Towers were attacked. Funding dried up quickly because every source was unsure what was next. To preserve the transactions we had to pivot and we discovered innovative financing which we still use today. Now it really doesn't matter what the economy does. Since there are only a few moving parts in finance, you adjust one part to make the others work. We got through 2008-2009 relatively unscathed because we had learned how to adjust quickly.

Alex S. · Answer

The comparison people miss is that in 1996 you were buying at 9-10% caps with 8% money, so the spread was still positive. At a 5.5% cap with a 6.5% loan you have negative leverage, and the only ways out are a bigger down payment, buying value-add where your stabilized cap is 8%+, or betting on rate cuts. If the deal only works on the refi, it is not a deal yet.

Diana Khan · Answer

@Steven Williams, I’ve seen this come up with investors, and the part I always come back to is how many things have to go right for the deal to work. If the numbers only make sense because rents have to rise, rates have to drop, or the property has to appreciate, that leaves very little room when something does not go as planned.

I also like looking at the exit before getting too excited about the purchase. I’ve worked with deals where the property itself was fine, but the cost and timing of refinancing or selling made the return much tighter than expected. For me, a deal feels much stronger when it can carry itself under today’s numbers and anything better later is just a bonus.

I’d be glad to stay connected, @Steven Williams. I like conversations like this because the best deals I’ve seen usually have some breathing room built in from the start.

Michael Eskenasy · Answer

The cleanest line for me is the spread between the going-in yield and the debt constant. A 6% cap against roughly an 8% annual P&I constant means the property is asking appreciation, rent growth, or a future refinance to rescue the leverage. That may still be a valid thesis, but it is no longer income investing in the traditional sense.

My walk-away test is simple: if the deal only works because rates fall later, it doesn’t work today. I’d rather buy something where current operations can carry current debt, then treat any refinance or appreciation as upside.

Kasing Ng · Answer

Hi Steven,

I was not investing in the 1990s, and I am not a property syndicator or active buyer. My perspective comes entirely from financial modeling and underwriting.

To answer your direct questions based on what the numbers show:

Yes, positive leverage was standard in the 90s. Borrowing at 8% while buying at a 10 cap created immediate, real cash flow. Today, borrowing near 7% to buy at a 6 cap means negative leverage. Cash flow is underwater on day one.

If someone is buying with negative leverage right now, his/her entire thesis is a bet on rent growth or a rate drop. If rates stay flat for five years, projects with maturing bridge debt or balloon payments will face a capital crunch. When refinancing requires cash injections the asset does not generate, equity gets wiped out.

When the market locks up, transaction volume drops first. Sellers refuse to lower nominal prices, so deals simply stop happening. Prices only drop when forced liquidations, maturing debt, or distressed owners finally break the standoff.

Very few deals clear the loan constant today without heroic assumptions. The few that actually work involve heavy distress, deep below market rents, or operational mismanagement where you can immediately force net operating income higher.

From the numbers standpoint, compressed operating margins also leave zero room for unhedged exit taxes like depreciation recapture. If a pro forma ignores that tax drag, the final cash return will fall short of the original projection.

1996 rates were higher and deals worked. Where do the numbers stop making sense?

1996 rates were higher and deals worked. Where do the numbers stop making sense?

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