Rising interest rates may be squeezing profit margins, but there are still deals that offer competitive returns, so the most experienced investors are forging ahead regardless. Rookies can learn from their flexibility but must understand how the changing lending landscape will impact their goals. We asked lending experts how the Fed’s reaction to inflation affects lending so that investors can be prepared to adapt accordingly.
Here’s what you need to know about the Fed’s current and future plans and what they mean for your real estate business.
What The Fed Has Been Doing
The Fed is currently charged with cleaning up the inflationary mess caused by government stimulus, supply chain disruptions, and the Russian invasion of Ukraine. The tools they’re using are impacting mortgage rates and the corresponding affordability of housing.
After the Fed announced the steepest rate hike in decades, the mortgage rate increased 55 basis points the week of June 16, 2022, the largest one-week change we’ve seen since 1987, according to Freddie Mac. The Fed didn’t stop there. They increased rates by 75 basis points again in late July.
And that’s not the only action from the Fed that is causing concern for investors. Part of the cleanup will require quantitative tightening—or the selling of mortgage-backed securities that the Fed purchased to increase the monetary supply during the pandemic.
According to an Axios report in May, the Fed purchased $1.3 trillion worth of mortgage-backed securities during the pandemic, amounting to $2.7 trillion total on their balance sheet. As the Fed begins to sell off these assets, it will force the economy to slow and spur another increase in mortgage rates.
At the same time, mortgage supply is decreasing due to tightening lending criteria, particularly refinance loans.
The changing lending landscape challenges real estate investors, but those willing to bend rather than break may also find that it provides opportunities. We checked in with lending experts to find out how investors can prepare for potential interest rate hikes and react to changes in the housing market.
The Impact On Lending
Anticipation of the Fed’s actions has just as much of an effect on mortgage rates as actual interest rate fluctuations, so consumer rates were already baked into the market before the Fed’s announcement. Lending experts at Lower.com report that the pool of buyers has already changed in response.
“We saw a lot of customers who have been dragging their feet on buying, kind of pull the trigger, or really get serious about it. It’s almost pushed them further into the market because they just see the upward momentum of interest rates,” says Chelsea Wagner, Senior Vice President of Partnerships.
Buyers are anxious to get into the market before it’s too late.
While interest rates and home values will continue to rise, competition has dampened slightly. A modest increase in inventory alongside a decrease in affordability has decreased the number of offers submitted on each home. Still, the average loan amount has remained steady, Wagner says.
Another change is that buyers are approaching deals with more assets to make aggressive offers or cover an appraisal gap. Higher interest rates don’t leave space for buyers who come to the table with less wealth, especially as underwriting criteria tighten.
According to Bill Lyons, Founder and CEO of Griffin Funding, investors with different levels of experience have different reactions to the changes. While some less experienced investors are walking away from real estate entirely, more experienced investors are shrugging it off.
“More sophisticated investors were not surprised,” says Alex Bekeza, Loan Officer at Investor Property Loan, of the June rate hike. Rather than recoil, these more experienced real estate investors altered their strategies or sought deals that would still be profitable under the new conditions.
What We Can Learn From Professional Investors
Full-time investors who continue to invest are finding creative ways to get favorable outcomes.
Lyons says he’s seen investors use adjustable-rate mortgages to achieve a low enough debt-to-income ratio to make deals work. The lower interest rates on these mortgages during the initial fixed period allow for lower monthly payments. Additionally, Bekeza says he’s seen an increasing number of investors maximizing the opportunity to buy down the rate with cash. This can help maintain a workable debt service coverage ratio.
RJ Lindenmuth, SVP of Refinance at Lower.com, mentions, “Rates going up have helped people realize time is of the essence in this market cycle. And that goes for purchasing or refinancing.”
Lyons says it will be important to form a board of advisors for deals going forward. Contact your CPA, financial advisor, and loan officer to ensure everyone is on the same page with your investment strategy. Establish plans for how you’ll proceed if interest rates drop—and what you’ll do if they climb even higher. Most importantly, educate yourself and your team about the ins and outs of real estate investing in a rising interest rate environment so you can adapt.
For example, Bekeza says some investors use mortgages with longer-term, interest-only periods. This sets them up to refinance at a lower rate later on if rates fall at any point. However, Bekeza says you shouldn’t count on interest rates declining any time soon. In the meantime, he expects that investors will need to bring more cash out of pocket to buy down rates.
It’s also essential to move quickly in the changing environment, says Bekeza. BRRRR investors, in particular, need to pay off their short-term loans faster and refinance into longer-term loans.
However, don’t rush the process so much that you fail to crunch the numbers. Plug in the current interest rate and ensure the numbers still work to achieve the internal rate of return you’re looking for. One rule of thumb that may be helpful to remember is that a one percent increase in interest rates results in an approximately 10% decline in buying power.
You can find a BiggerPockets Real Estate Investing Calculator for virtually every strategy. Use these to see how a higher interest rate will impact your return and adjust your goals accordingly.
Be Prepared For Anything
Given that mortgage interest rates are rising, you may likely find fewer deals that make sense when you run the numbers. This may require some extra patience and cause some frustration, but walking away from real estate entirely could mean missing out on some great opportunities.
Instead, check in with your loan officer, CPA, and financial advisor. Wagner recommends preparing for those conversations with detailed information about your budget and investment strategy. The more your team understands your situation, the better they’ll be able to make suggestions on how to structure a deal to get the most profit.
Furthermore, be prepared with plans for various scenarios so that interest rate hikes won’t catch you off-guard, and you’ll be ready to take advantage of a decrease.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
