Updated: Sep 8, 2021
Throughout most of the pandemic, interest rates have been extremely low. As a result, incredibly high numbers of people have rushed to obtain mortgage loans in order to buy properties with less expensive debt. The result has been a strong seller’s market that has lasted for well over a year now.
However, with the pandemic slowing down, many people believe that interest rates will soon begin to rise. Increasing interest rates are often perceived as a bad thing for the real estate investing market. However, the truth is that there are a number of key "pros" for increasing interest rates. In this blog, I will break down the most important pros and cons that you need to be aware of regarding rising interest rates.
Cons of Rising Interest Rates
When debt is more expensive due to higher interest rates, the returns on real estate investments can be lower, as more of the income that comes in every month has to be put towards paying interest instead of going straight into the investor’s pocket. The difference may not seem that significant in the short term, but these numbers can add up over time. Paying higher levels of interest and taking lower levels of profit is something that can turn some investors away from real estate investing in a higher-rate environment. The higher the interest rates are, the more problematic they are viewed as for a percentage of real estate investors.
A Flight to Bonds
When interest rates increase, a significant amount of real estate investors move back to bonds. This happens because bond investors believe that they will be able to achieve higher returns with bond yields than with real estate investments. In other words, higher interest rates are viewed by many investors as a direct hindrance to a healthy ROI. This scares many of them into other assets like bonds. However, even though many types of bonds are considered to be safer investments by many people, their rate of returns can be low over time too. So, moving to bonds during periods of higher interest rates does not guarantee higher returns by any stretch of the imagination, and could be a mistake.
Pro of Rising Interest Rates
Yes, it is counter-intuitive; after all, why would increasing interest rates be a positive force in the real estate investing arena? The answer is, like in many cases, in the macro forces that impact real estate.
Stronger Demand for Multifamily Housing
As the rising interest rates are putting pressure on multifamily returns, and more investors are turning to bonds, demand for single-family housing tends to increase among institutional investors. Currently, institutional investors are buying single-family homes by the hundreds or thousands as portfolios, which is increasing prices in the single-family home market for an obvious reason: institutional buyers can offer higher prices and faster closings than the average Joe can. In fact, institutional investors spent a record $77 billion on single-family homes between December 2020 and May 2021.
Since future homeowners are now competing with huge corporations, it becomes even harder for them to find a house, and more and more people turn to renting an apartment instead. Many future single-family home buyers keep getting outbid and priced out by bigger players.
Higher SFH Mortgage Interest Rates
In addition to being priced out by institutional buyers who are buying up large numbers of single-family homes, many people will also soon start having to deal with increasing mortgage interest rates for single-family homes. Higher mortgage interest rates will make the dream of buying a house less affordable, leading to even stronger demand for multifamily housing by renters who cannot afford to own a house. This is especially true in urban areas where housing prices are typically higher and where there are higher concentrations of people living in a given area. For this reason, multifamily properties in urban areas can make for excellent investments for real estate investors.
What Does This Mean?
What this means is that even if interest rates rise significantly in the next few years as the pandemic dies down and the federal reserve changes its policies, it does not mean that the multifamily investing market will suffer. On the contrary, there is a very good chance that it will do even better. There are many reasons why this is the case.
According to Forbes, the average interest rate for single-family houses has already started to rise, and mortgage applications decreased 11.4% in a single week in February. Fewer mortgage applications mean that greater numbers of people will be looking to rent units in multifamily properties. This creates a good opportunity for investors who are interested in multifamily property investing.
Is Multifamily Real Estate Investing Right for You?
Many investors are asking themselves this question right now. This is because rising interest rates are going to change the game. So, investors are having to choose between multifamily real estate investing, bond investing, and other types of investing. The federal reserve has also recently announced that its inflation projections are 3.4%, which is a full percentage point higher than its March inflation projections.
Rising inflation is not a surprise to many investors due to the unprecedented amounts of money printing that has occurred during the COVID pandemic. However, even though it might not be a surprise to savvy investors, it is still something that most investors are going to have to deal with in one way or another. So, now many investors are also considering classic inflation hedges such as gold in their portfolios.
If you are trying to choose between real estate, government bonds, corporate bonds, commodities like gold, or other assets for your major investments in the next few years, then you should be aware of the most significant positive aspects of multifamily property investing. Multifamily housing has a tremendous number of advantages compared to other investments, and these advantages should not be overlooked.
Here are some of the top benefits of multifamily investing:
Strong Monthly Cashflow
Multifamily properties are one of the single best ways to generate cash flow. Whether you invest in a ten-unit property or a one-hundred-unit property, multifamily properties tend to generate strong monthly cash flow that remains very steady throughout the year. Many investors prefer multifamily properties due to their lack of volatility and their reliable cash flows. Even when tenants move out, it is usually easy to find a new tenant as long as the property is in good condition, because everyone needs a place to live. As mentioned above, rising interest rates will also likely drive higher numbers of people into multifamily properties, making them even more steady and reliable.
Property values tend to increase in value over time in America. Because of this, multifamily properties can serve as an excellent inflation hedge. When property values go up, rents can increase, earning more profits and ROI for the investor. Considering the fact that the fed’s inflation rate projections rose sharply recently, it might be a good idea for many investors to start looking into assets that can help them to hedge against inflation. The fact that multifamily housing investments can appreciate in value over time gives them a significant advantage over many types of bonds, whose value can remain static for many years, leading to subpar returns.
One of the best tax advantages of multifamily real estate investing income is that it is not subject to self-employment taxes. Also, the government offers a wide array of tax breaks for things like depreciation, legal fees, property taxes, maintenance, etc. Additionally, multifamily real estate investors also get lower tax rates for their long-term investments compared to other types of long-term investments. So, you can experience many important tax benefits by investing in multifamily housing.
Long-Term Financial Security
Unlike other investments like stocks or commodities which can be very volatile, multi-family property investing can set you up for genuine long-term financial security. The stable monthly cash flow combined with the appreciation and tax benefits that multi-family housing investments offer are ideal for growing wealth steadily over time. Multifamily properties are an extremely secure investment because there will always be demand for housing and not everyone will be able to afford single-family homes.
Unfortunately, many investors fall into the trap of fleeing multifamily real estate investments just because interest rates might rise. It is true that it can be easier to finance purchases and experience higher profit margins when interest rates are low and when debt is cheaper. However, this doesn’t mean that multifamily properties are still not a great option when interest rates rise.
Rising interest rates combined with other factors such as record buying of single-family homes from institutions are helping to drive more and more people to seek out multifamily housing. This trend is likely to continue over the next few years as the pandemic ends and as interest rates rise.
Multifamily real estate investing offers a tremendous number of benefits to investors that can make these types of investments significantly more beneficial overall compared to other investments like gold or government bonds. These benefits include steady cash flows, extreme security, appreciation, tax advantages, and more.
If you are trying to choose where you should put your money in order to optimize returns and financial security over the next few years, then you should strongly consider investing in multifamily properties. If you need assistance with multifamily housing investments, feel free to get in touch today.
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About the Author Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to. A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology. Ellie is the host of REady2Scale, a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for successful real estate investing. She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations. Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management. You can read more about Blue Lake Capital at www.bluelake-capital.com and learn more about Ellie at www.ellieperlman.com.