Waiting for Rates to Drop to Buy Commercial Property?

Waiting for interest rates to drop before buying commercial property might seem wise, but it begs the question: Are rates actually going to drop? And even if they do, will it be enough to justify waiting? Should interest rates be the only deciding factor? And when is the best time to buy? In this video, you’ll discover the answers to these questions plus a whole lot more!

 

Is It Worth Waiting for Rates to Drop?

To answer this question, I’ll illustrate with a straightforward example: purchasing a 12-unit apartment complex at a 7% interest rate compared to waiting two years for a 6% rate. This detailed financial analysis will contrast the two scenarios, highlighting the impact waiting has on cash flow, mortgage reduction, forced appreciation, and depreciation.

Cash Flow Comparison: Buy Now at 7% vs Wait and Buy at 6%

12 Unit Multifamily
Purchase Price: $1 million
Down Payment: 25% ($250,000)
Mortgage: $750,000, 30 Year Amortization
Annual Income: $125, 964

Buy Now at 7%

$4990 Monthly Mortgage Payment

To determine the cash flow, you first need to calculate the Net Operating Income (NOI) by subtracting your expenses from the income. Then to complete the calculation, subtract the mortgage from the Net Operating Income.

•  $125,964 –  $48,000 = $77,964 (NOI)
• $77,964 – $59,880 = $18,084 cash flow

Wait 2 Years and Buy at 6%

$4497 Monthly Mortgage Payment ($500 less because you waited)

• $125,964 – $48,000 = $77,964 (NOI)
• $77,964 – $53,964  = $24,000 cash flow

Was It Worth the Wait?

By waiting two years for a lower interest rate, you’ve increased your annual cash flow by $6,000. Looks good right? You have more cash flow, suggesting the wait was worthwhile. But is that really the case? What did you miss out on while waiting?

5 Year Comparison: Buy Now at 7% vs Wait and Buy at 6%

Cash flow is how much money a property generates for you as the owner; however, there are other benefits of commercial investing, such as mortgage paydown by tenants, forced appreciation, and tax advantages. When considering whether to wait for lower interest rates, these factors must be considered. A thorough analysis requires examining the effects of waiting on all the benefits of investment property. Again, I’ll illustrate this using the same 12-unit example, and examine cash flow, mortgage paydown, forced appreciate and depreciation over a five year period in both scenarios.

Buy Now at 7% 

Cash Flow: $18,084 x 5 = $90,000

Mortgage Pay Down: You were able to pay down your mortgage to$705,000.

Forced Appreciation: By improving the property’s financial performance you can increase your NOI which in turn raises the property’s value. For instance, in our example if we boost the rents by 5% annually, compounded over five years, this results in an additional $27,000 per year. To calculate forced appreciation, divide $27,000 by 6% cap rate. So, over 5 years you increased the value of your property by $450,000.

Depreciation: One of the most significant tax advantages for commercial real estate is depreciation, which is a federal income tax deduction designed to compensate for the costs related to the natural decline of your property over time. Straight-line depreciation allows for an annual income tax deduction that enables you to recover expenses due to the wear and tear of rental property across twenty-seven and a half years. However, the IRS permits depreciation only for the building, not the land. Since land it is not depreciable, exclude 20% of the property’s value, rendering the building’s worth at $800,000. Over twenty-seven and a half years, you can depreciate approximately $30,000 annually. Multiply that by 5 years, and it results in $150,000 in tax deductions.

Wait 2 Years and Buy at 6% 

By comparison, if you wait two years for rates to drop, you won’t generate cash flow or reap the other three benefits during the initial two years of the same five-year period. For this reason, your investment calculations begin in the third year.

Cash Flow: $24,000 x 3 = $72,000

Mortgage Paydown: You were able to pay down your mortgage to $720,000.

Forced Appreciation: By not starting until the third year and then raising the rents by 5% compounded over a three-year period, you achieved a $12,000 increase in annual income. When this is divided by a 6% capitalization rate, it results in a forced appreciation of $200,000.

Depreciation: Again, using straight-line depreciation, you can allocate an equal amount of $30,000 over years three, four, and five, amounting to a total of $90,000 in deductions.

Was It Worth the Wait?

After crunching the numbers, the question remains: is it more profitable to purchase now or wait for a rate decrease? Comparing both scenarios, if you were to buy today at a 7% rate, then after five years, you would end up with:

• $18,000 more in cashflow
• Paid down your mortgage by $15,000 more.
• Benefited from an additional $60,000 in tax write offs.
• Force your appreciation $250,000 more.

Waiting two years for a 6% rate means missing out on $343,000 over five years. Therefore, holding out for lower rates might not be the most financially sound choice. In fact, starting to invest sooner, even at a slightly higher interest rate, can lead to greater long-term gains compared to waiting for rates to drop.

Other Key Factors

While interest rates are a significant factor, they are not the sole determinant in the purchase of commercial property. Financial, personal, and legacy factors also play a crucial role.

Financial Factor: These financial considerations are the cashflow, mortgage paydown, tax write offs and forced appreciation. After breaking down the numbers, the evidence is clear, interest rates are not the sole financial factor to consider when deciding to buy investment property.

Personal Factors: What are your personal goals? Do you feel like you are a few years behind on investing? The way to stop that is to start now and then a few years from now, you won’t be behind! Starting with a small multifamily property, mobile home park, or self-storage business is perfectly fine. Like many of our students, you can begin with a smaller property and expand over time; the key is to take the first step.

Legacy Factor: Everyone has a purpose. What is yours? Is it to provide for your family, or perhaps to contribute to a ministry or charity? We all aspire to leave a legacy, and investing in commercial property can be the means to build a lasting legacy for you and your family.

When is the Best Time to Buy?

The best time to buy commercial property was 5 years ago; the second-best time is now. But you still need to buy right. With 20 years of experience advising on commercial real estate investment, we guide on what to do—and what not to do—when acquiring investment property. Commercial real estate investment is NOT mere speculation or a gamble on the future, and it’s not about trying to time the market. Whether the market is up or down, the rates are up or down, our formula for success and disciplined approach, honed over years, yields consistent results.

If you have any comments or questions, text PETER to 833-942-4516.

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