Discover how commercial real estate investors are impacted by higher interest rates and how you can thrive as rates rise:
4 Ways Rising Interest Rates Impact Commercial Investors
1. Cashflow: As interest rates go up, the cash flow will decrease because climbing interest rates have caused a higher mortgage payment and it may kill the deal.
2. Return On Investment (ROI): Cash on cash return will drop because of less cashflow. In fact, it may drop so much that the ROI may not be attractive enough to do the deal.
3. Economy: When interest rates go up, things get more expensive. And if the Feds don't handle the inflation correctly, it will send us into a recession.
4. Real Estate Demand: Demand for real estate will trend downward as interest rates rise because people can't afford a mortgage anymore. All of this may lead to a fear of a market crash.
How to Thrive When Rates Rise
1. Don’t Wait!
One of our student investors purchased a small multi-family apartment building a few months ago. As his mentor I encouraged him to do it, but he was disappointed because he didn’t feel good about the interest rate and he thought he slightly overpaid.
A few weeks ago, he called me to tell me that he was glad he did it. When I asked him why, his response was two-fold. First, the apartments in the area are selling for much more now, even though rates are higher than when he closed the deal. And secondly, the rents on all his units went up by 10%. Had he waited, he wouldn't own that apartment building, have the appreciation, extra income, or the tax write offs. If you want to thrive when interest rates are rising, do not wait!
3 Reasons Not to Wait
- Apartment Prices Aren’t Going to Get Cheaper: There's a quote that says, “You don't wait to buy real estate. You buy real estate and wait.” Apartment prices aren’t going to get cheaper. Some of you are waiting to purchase an apartment when the market crashes. I don't believe that's going to happen. You will be waiting a long time and end up an old person with nothing.
- Economic Volatility Leads to Greater Demand for Rentals: As a commercial investor I’ve experienced economic volatility twice. Both times the trend moved away from home ownership and there was an increased demand for rentals. People became renters and more tenants became longterm renters. That benefits apartment investors because as the economy tanks, there is a larger pool of renters. With higher demand and the supply the same, your rents will increase and so will the value. That's a great reason not to wait.
- Supply and Demand Crisis: There is an affordable housing shortage in the U.S. and we aren’t even close to solving this problem. They can't build homes and apartment buildings fast enough to meet the needs of people. We were already far behind, but now combined with inflation and increased building costs, it is even more challenging. Take action now!
Most middle class look for guarantees, but we teach our students to look for opportunities. That's a huge difference in the mindset, and you need the right mindset to do well and thrive in this business. In my video Do You Have the Right Mindset for Commercial Real Estate? I teach what the right and wrong mindsets look like as well as practical strategies on how to replace the wrong with the right so you can become a successful commercial real estate investor.
2. Focus on Net Operating Income (NOI)
Our top students have done one thing incredibly well and that is monitor their net operating income. To calculate your NOI take your income and minus the expenses. The remainder is your net income. From your net income you pay the mortgage, and the remainder from that is your cashflow. So, that’s how cashflow is calculated and how property value is determined.
When you manage your NOI well, your cashflow is consistent and your property value increases. When these two things happen you have many options: you can retire, do a cash-out refi and take your down payment out to purchase another property, or do a cash-out refi and pay off investors.
3. Efficient Operation: You need to be NOI-focused when interest rates are rising because there's less margin for error. Cashflow is slightly challenged, so you need to become a good operator for whatever commercial property you purchase. We teach a strategy at CPA for operating a finely-tuned commercial property. It’s called the Four Ms and includes systems for management, money, marketing, and maintenance. These systems ensure your NOI stays strong.
Whether you're a beginner investor or a seasoned veteran, the NOI in this economic environment is extremely important. As you know, as the NOI goes up, so does the cashflow and property value. So, don't focus on rising interest rates and prices going through roof. Instead focus on evaluating your property: what is the NOI today and how can I take it to the next level? That needs to be the focus.
Thorough Evaluation: Wanna do a bad deal? No, you don't. But if you did, all you would need to do is a sloppy evaluation. Right now there's zero tolerance for that with rising interest rates. You cannot do a sloppy evaluation. To help you become better at evaluating apartments and commercial real estate watch: Analyzing Commercial Real Estate Quickly and Easily.
4. Creative Real Estate Financing
One of our Proteges, Dean, recently closed on a very large self storage facility in Tennessee. The problem with that property was 40% of it was vacant. So combined with the large down payment required and the higher interest rates, the numbers just didn't pencil out. One way to counter these challenges is learn how to do creative commercial real estate. Our student only put down 10% and the seller financed the rest. Once it is 100% occupied the building will be worth two times more than what it was purchased for. Those are the kinds of challenges that creative real estate techniques can overcome.
When a motivated buyer and a motivated seller come together, beautiful things can happen.
Learning creative financing is an absolute must when interest rates are rising because some deals just won't pencil out. The solution is seller financing, and I believe we at CPA are the best in teaching this strategy. There are four general techniques for seller financing.
- Master Lease Agreement: This is our favorite technique and I have a video that details how it works. Essentially you purchase an apartment building or storage facility with a small down payment. There are no banks involved, no credit checks, or appraisals if you don't want it. It’s strictly between you and the seller. Although it’s not a new technique, it’s a very powerful tool. It's been around for years, but no one knows about it or practices it.
- Instalment Sale: With this technique you buy the property from the seller in pieces. Again, you use this tool because the numbers don't work due to higher interest rates. This is also a powerful technique because it helps the seller with capital gain taxes.
- Seller Carry First Mortgage: I love this technique because the seller becomes the bank for the buyer. Again, it's a great way a motivated seller and motivated buyer create beautiful things.
- Seller Carry Second Mortgage: The seller assists the buyer with a down payment by taking part of the down payment required by the bank, and piggyback it on the seller as a seller carry second mortgage.
Put all four of these techniques in your toolbox to thrive as rates rise.