Frustrated by High Interest Rates? Review Your Options

[Image generated with Dall-E]

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.