Frustrated by High Interest Rates? Review Your Options
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Investing in real estate during the current high interest rates can be frustrating, but delaying your investment might cost you more in the long run. Here’s why:
Financial Impact of Waiting
If you bought a $400,000 property today with 30% down, your down payment would be $120,000. Assuming a 7.5% interest rate, your principal and interest (P&I) payment would be $1,958/Mo.
What happens if you wait three years for interest rates to drop to, say, 5%? Let’s look at potential property appreciation:
(In our 2024 Las Vegas Investor Outlook, I stated that I expect our next 5-year average appreciation rate to be over 11% and the rent growth rate to be ~8%, and why.)
Market Value After 8% Annual Appreciation:
- After one year: $432,000
- After two years: $466,560
- After three years: $503,885
Market Value After 10% Annual Appreciation:
- After one year: $440,000
- After two years: $484,000
- After three years: $532,400
If you wait three years and interest rates drop to 5%, your 30% down payment would be:
- 8% appreciation: $151,166
- 10% appreciation: $159,720
Note: When interest rates decrease in the future, you can make a smaller down payment, such as 25%. However, your loan amount will be larger, and obtaining a loan at that time may involve points or other costs that we cannot predict. Therefore, I used a 30% future down payment to simplify things.
Principal and Interest Payments After Three Years:
- At 8% appreciation at 5% interest: $1,895 per month
- At 10% appreciation at 5% interest: $2,001 per month
Loss of Equity by Waiting:
- If 8% appreciation: $103,885
- If 10% appreciation: $132,400
Buy Now, Refinance in the Future
If you purchase the property today for $400,000 and refinance after three years at 5%, your P&I would be $1,503/Mo. The result would be significantly higher cash flow. Additionally, you would have accumulated equity, cash flow, and tax savings.
Rent Growth:
Assuming an initial rent of $2,000 per month with an 8% annual increase:
- After one year: $2,160
- After two years: $2,333
- After three years: $2,519
Summary of Financial Impact:
Waiting three years for lower interest rates means:
- At 8% appreciation:
- Equity loss: $103,885
- Increased down payment: $31,166
- Loss of rent (as rent rises, properties have increased cash flow.)
- Loss of tax savings
- At 10% appreciation:
- Equity loss: $132,400
- Increased down payment: $39,720
- Loss of rent (as rent rises, properties have increased cash flow.)
- Loss of tax savings
Options
Here are what I believe to be the available options for investors.
- Do not buy real estate: This means missing out on the most proven method of financial freedom. I’ve discussed alternatives to real estate with many clients, but none have found a good alternative.
- Buy real estate in low-cost locations: These areas may offer initial positive cash flow and cheaper properties. However, appreciation and rent increases in these areas are around 1%. If (real) inflation is 5%, the buying power of your rent and the equity you invested in these properties will decrease by about 4% per year. See “The Allure of Low-cost Markets” and “Why Low-Cost Properties Are the Most Expensive.”
- Buy real estate today and accept initial negative cash flow: Many clients are adopting this strategy. They believe that with rising rents and property prices, they will achieve positive cash flow within one or two years.
- Buy real estate today and put more money down: Most clients are putting down between 30% and 35%, depending on the property and interest rate, to achieve positive or zero cash flow.
- Wait until interest rates fall: Property prices are rising, so waiting might cost you more even after interest rates decrease.
Keep in mind that if you do not have sufficient funds to acquire and renovate a property, plus a comfortable reserve in case of an emergency, do not do it.
Conclusion:
Investing in real estate during high interest rates can be frustrating, especially compared to the investing environment before the interest rate hikes. But we are now in a new era, and waiting can lead to a significant loss of returns. By taking action now, you will benefit from property appreciation, rent growth, and tax savings, setting yourself up for future financial success.
