The Impact of Rising Interest Rates for Real Estate Investors

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If you’ve been active in the real estate market over the last several years, you’ve watched with the rest of us as mortgage interest rates fell … and then fell some more …. and then just when they were about to rise … they fell even more. Who would have imagined mortgages as low as 3% just a few years ago?

It’s been phenomenal for buy and hold real estate investors who have been able to achieve fantastic cash on cash returns with such favorable financing. Wouldn’t it be great if we could all just sit back and plan on low purchase prices and low interest rates for years and years to come? It certainly would, but I definitely wouldn’t bet on it. In fact, in just one year, we’ve seen real estate values make major strides towards pre-recession prices. And what I would argue is equally notable, interest rates look to be on the rise as well. In fact, the chief executive at JP Morgan Chase was recently quoted as saying “I think you all should be ready, because rates are going to go up.”

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What’s the Impact

Many investors are watching rising real estate values with a sense of urgency to purchase while the deals are still good. However, I would argue that while increasing prices are definitely a motivating factor, rising interest rates are just as, if not more important to watch. Interest rates are definitely less predictable than rising values and can move in either direction much quicker as well. As we all witnessed just this last month, any minor shifts in policy or market demand can have a tremendous affect on mortgage interest rates and can affect future returns on an investment on a moments notice.

For example, let’s say you are getting a loan on an investment property for $100,000 at 4% interest (assuming 20% down on a purchase price of $125,000). Your principle and interest payment is going to be $477 and for the sake of this example, let’s say you anticipate monthly cash flow of around $300/mo.

Now what if you wait a few months to buy this property and interest rates jump a full point to 5%. Your principle and interest payment goes up to $536 a month – an increase of almost $60/mo. Your monthly cash flow now decreases to $240/mo. Do you realize that your monthly cash flow decreased by 20% as a result of your interest rate going up by a single percentage point?!

Strictly analyzing this from a cash flow perspective, that 1% increase in interest rate is actually the equivalent of that property increasing in value by $15,625 dollars! That’s right, if the property were to increase in price to $140,625 and you were able to get a loan for $112,500 at 4% (again, assuming 20% down on a purchase price of $140,625), your principle and interest payment would actually be the same as the $100,000 loan at 5% interest.

Bottom line – in terms of cash flow, that 1% increase in interest rate represents a difference in value of $15,625 dollars in this example! It also represents a 20% decrease in monthly returns.

I don’t know about you, but I’ve never been more motivated to finance properties before this incredible ride comes to an end. We all know that our economy can’t sustain these low interest rates for much longer. It wasn’t that long ago that investors were getting loans in the 6 and 7% range … and my guess is that’s where we will find ourselves in the not too distant future. I think investors would be well advised to take advantage of financing in the sub 5% range while we still have an opportunity.

Photo: Werner Kunz

About Author

Ken Corsini

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

11 Comments

  1. Ken:
    We bought our first investment properties 10 years ago at a 9% rate. We were thrilled to get a single digit rate.

    So true, rates will not stay this low. If they economy is to truly rebound, rates must go up. Grab your “free” cash while you can!

  2. The main question I have is what the impact of rising rates will be on rising home prices. So, if homes in a given area were projected to increase 5 to 8% in the next twelve months, what will the likely increase be if mortgage rates rise another 1%?

    • Ken Corsini

      Toby – I think this is the million dollar question. It’s going to be different for every market – but the extent that interest rates are driving the market has yet to be seen. I would imagine that increasing rates will have to slow down the rising values … but we’ll just have to wait and see by how much.

  3. The problem is that when interest rates rise property values come down – they have an inversely proportional relationship. If interest rates were to rise from the current 4.5% to the historic average of 8% property prices would have to drop 40% to keep the same mortgage payment, with incomes stagnant we’re not looking at a good situation here.

  4. Bernard Pierson on

    My concern here is that if interest rates rise, investors will have better returns in other asset classes (bonds, cds, loans). This would make investors expect, or only be interested to invest at higher cap rates. My question is, do you think an increase in interest rates, expect and increase in cap rates and therefore a lower property value, at least to some degree? Is this correct?

    Historically, has this been a result of higher interest rates on investment properties? It might be good to analyze historical cap rates.

    Thanks

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