As interest rates rise, how does your business change?

Question

This is assuming interest will continue to rise. For me, my long term goal is to own doubles in my A neighborhood, that currently are 150K +. And 5% + interest starts to really cut into the profits. I'm not real excited about potentially having to pay close to 10K in interest a year in the coming years. I'm conservative by nature and like low debt and low risk, but also realize this can limit you from scaling up. I would like to gain more understanding in this area.
Seasoned investors, how do you view interest rates?
And how do you adjust your business accordingly?

I just watched this gem of a biggerpockets podcast:
https://www.youtube.com/watch?v=pvow1ifO3Qk

And the guy said 3/4s of the way through the podcast that appreciation rises a long with the interest rates which I thought was very interesting.

Thanks in advance
-John

And the guy said 3/4s of the way through the podcast that appreciation rises a long with the interest rates which I thought was very interesting.

Thanks in advance-John

Curtis Bidwell · Answer

Interest rates don’t matter as much as your criteria does.

If your looking to get a 10% return you’ll consider the price, down payment, interest rate, and factor in all other expenses as well.  You can get a 10% return with a 4% rate as well as a 14% rate depending on all these factors.

It generally takes awhile for sellers to adjust their thinking/pricing as rates increase.  They saw their value as $x when rates were 4% and don’t want to admit the value has gone down when rates hit 6%! These will adjust more or less depending on the area and market demand.   In high demand markets modest rate increases won’t effect prices as much as they will in softer markets.

Again, stick to your criteria and buy when it makes sense regardless of the cost of $.

Curtis Bidwell · Answer

@John W. Home values will not go down due to lack of demand - that is only true to a slight degree as in the case of interest rates jumping significantly.  Incremental increases should have a nominal effect on the demand side of things.

But on the affordability side: The reality is, people can only afford so much of a payment based on their  income.  If my budget allows a payment of $950/Mo (p&i), I can afford a $200k home at 4%.  But when rates go to 5% I can only afford $175k home.

Now I have to choose a cheaper home, OR ... the seller has to adjust the price to keep the demand.  Both of these will happen to a degree.

As rates go up Prices will soften unless there are factors driving demand (an example is Seattle where my son bought a 3 bed, 1 bath 1300 sf rambler for $650k! Factors such as high job growth and not enough housing stock available is pushing prices through the roof DESPITE increases in interest rates.)

My first investments were in the 8% range.  I’ve had them as low as 2.875%. I’ve made money at both ends.  Higher interest may mean fewer people in the market which leads to less competition!

So go make a deal that works for you based on your criteria of return on investment or dollars per door - not based on an interest rate.

Brian Ploszay · Answer

Higher interest rates will cut into valuations of rentals for sure.  But I wouldn't worry about it yet.  Expect gradual increases.  If the interest rates rise too much, wait until the market reprices itself.

Account Closed · Answer

@John W. - I wouldn't get caught up with absolute statements like "appreciation rises along with interest rates". Appreciation rises based on multiple factors, interest rates is one but so is the location, population growth, wages, jobs etc etc. As an example of why you can't predict appreciation goes up with a single factor like interest rates, just look at the last 10 years - most areas have experienced tremendous growth in appreciation yet interest rates have stayed low.

It sounds like your goal is to buy and hold, in which case I would just focus on buying in good locations, make sure you have strong cash flow, and lock in your interest rate with 30 year mortgages.

Think about it, if someone offers you a fantastic deal today with a 30 year fixed rate mortgage, are you going to say "This looks amazing, but I will pass because interest rates are going up"?

Daniel Koch · Answer

I do not think your business should change... if a .25% is going to change your model then you are not giving yourself enough room to make a profit!

John W. · Answer

@Brian Ploszay @Curtis Bidwell thanks for chiming in. That is good advice. So as interest rates increase, home values go down because of less demand? I still think the rates are pretty good and would like to lock in some deals before they creep up too high. I also would like to get myself in a position in the next few years to be able to make cash offers and only use bank financing when I have to.

As interest rates rise, how does your business change?

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