Is Now a Good Time to Invest in Real Estate Opportunities?
by Christopher Levarek
“Courage is knowing what NOT to Fear”
- Plato
The topic of today, is whether now is a good time to invest in real estate opportunities. As many of you are probably quite aware, at present, in 2022, inflation is at a high 7%. Recently the Fed issued notice they would being an interest rate hike to combat this inflation, which would be introduced by March of 2022 and slowly increased in three increments. After injecting trillions of dollars into the economy with the stimulus packages, the effects are being felt by everyone as prices and labor costs rise in varying industries.
In reality, the economic policy in the United States has been kicking the can down the road for awhile now. Many have been calling that we are due for recession since 2018, and I was even one of them back in 2019 as we saw the “yield curve inversion” in March of 2019, see this article to learn more on this indicator. So now that inflation is here, what does it mean? Should we not invest in real estate? Let’s jump in!
Inflation and What It Means for the Consumer or Investor
Alright, so inflation by definition is a “general increase in prices and fall in the purchasing value of money”. It simply means, the currency can not buy as much and things are more expensive. We have seen this everywhere from gas prices, food products to industrial products such as fertilizer.
This means for a person making say $15/hour, it becomes harder to purchase normal goods and services for that $15/hour. When it comes to real estate, a person who could once afford perhaps a 3BR house in Phoenix, AZ, might be forced to buy a smaller house or rent.
Real estate is also directly correlated to the cheap debt or low interest rates(covered later) which allow people to buy more, thus also causing a rise in house prices. So with high inflation or rising prices, everyday consumers are affected in what they can purchase or buy.
Now investors, looking to invest in a product are pushed to invest in greater returns to make the investment worthwhile. For example, if an investor is used to seeing a 10% return on investment but losing 7% due to inflation, they might only be gaining 3%. So the investor might chase a 17% return instead so they are still gaining that 10% return, 17% - 7% = 10%.
This being said, the investor who on the other hand keeps large cash reserves in a savings account is losing out daily to inflation. A savings account might generate .5-2% at best, thus equaling a overall negative return of 1-5% for the investor on their stored cash due to inflation at 7%. So when it comes to investing, an investor investing in a 10% deal is definitely getting a better deal then the investor not investing at all.
Rising Interest Rates - What It Means for the Consumer or Investor
Now onto the second part of the story, the forecasted rise in interest rates by the Federal Reserve. Up until this point, rates have been kept artificially low by the Fed to stimulate the economy and encourage consumer purchases. With a rise in interest rates to combat inflation, the inverse can be expected as discussed.
Let’s look at an example for a consumer:
Joe wants to buy a 3BR house for his family in Phoenix, AZ
Price $600,000
Interest Rate : 4.5% increased rate at 30 year amortization
Payment now per month : $2432
That same house for Joe with a 3.5% interest rate in 2020, at the same price, would cost per month $2155.
So this means Joe is unable to perhaps make that payment for that new house because of a $300 per month increase. Thus Joe, might be inclined to not purchase that house, purchase a smaller house or perhaps even rent. So we have people being outpriced due to rising interest rates, all while inflation causes the dollar to not go as far for Joe.
Let’s Look at an example for an Investor:
Investor Sam has a lease contract with the haircut salon franchise “Super Cuts” for 1 of their store locations at a locked in rate for a 10 year lease. Super Cuts will pay that rate for 10 years according to the lease.
EXISTING
SuperCuts Lease : $4000 rent per month.
Sam’s mortgage : $2000 per month at 4.5% 20 year fixed.
Unfortunately for Sam, he had a 5 year balloon on a mortgage for this property which comes due end of 2022. This means he has to renew his mortgage at a new high rate end of 2022 at 5.5%.
NEW
SuperCuts Lease : $4000 rent per month.
Sam’s new mortgage : $2500 per month at 5.5% 20 year fixed.
Suddenly Sam’s costs go up for expenses, yet his 10 year contract forces him to keep renting at low cost to Super Cuts. Thus this investment might be underwater.
The example above showcases how a business plan already in place by investor could be affected dramatically with an increase in interest rate. The same becomes an issue for any investor executing a value-add project or a syndicator with a 1-2 year interest only bridge loan. Any project with short-term debt or non-fixed debt will be forced to use higher rates at a later date if not locked in.
Now of course, many investors will no longer be able to purchase and renovate property simply because it no longer makes sense to do so with the higher interest rates. Until seller’s lower prices, which isn’t expected in the next few years due to inflation and existing momentum, buying or transactions of real estate should decrease compared to previous years.
So Is it a Good Time to Invest in Real Estate?
The answer to the question above is……..YES! It is a very good time to invest in real estate and here is why.
Reasons to invest in real estate now:
Investing in hard assets of value(real estate) protects against inflation.
Investing in appreciating assets with returns counters inflationary negative returns(as discussed).
Rates are still incredibly low (We had 17% interest rates in the 80s! See image)
Rental growth is increasing yearly and expected to continue through the next three years at least.
Home ownership is on the decline, in correlation to above, meaning demand for rentals is rising.
Lastly as, Mark Twain said, “Buy Land, they’re not making it anymore”. If you will notice in all the above points, as investor, we are looking to protect our capital and increase our returns. Real estate unlike the dollar, is appreciating as it has a limited supply and is thus a great hedge against inflation.
To put it simply, investing in cash-flowing real estate projects in markets in expansion with long term fixed debt is the best plan during inflationary periods. Happy Investing!