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How Will Increasing Interest Rates Affect Real Estate Investors?

by | Jun 12, 2024 | Accredited Investor, BAM Blog, Blog, Real Estate Investing | 0 comments

How Rising Interest Rates Impact Accredited Investors Who Choose Real Estate as One of Their Investment Vehicles

When interest rates increase, it means the cost of borrowing money rises. Central banks typically raise interest rates to control inflation by slowing down economic activity. Higher interest rates make loans more expensive for consumers and businesses, which can lead to reduced spending and investment. This can mean higher mortgage, car loan, and credit card payments for consumers, reducing disposable income and dampening consumption. Read about “How Rising Interest Rates Impacts Multifamily.” 

Rising interest rates are a critical factor for real estate investors that can significantly influence their investment strategies. Higher interest rates can reduce return on investment (ROI) as mortgage payments become more expensive.

As a result, higher interest rates may dampen investor enthusiasm for new property acquisitions. They may instead shift their focus towards cash-flow positive properties or those with fixed-rate financing.

Interest rates have a profound effect on the value of income-producing real estate the same way they impact other types of investments. Some investors make the incorrect assumption that the current mortgage rate is the only deciding factor in real estate valuation. In reality, interest rates also affect capital flows, the supply and demand for capital, etc. [1]

Because interest rates are a crucial element in the world of real estate investing, it is important for investors to understand how it can affect them. In some cases, they may have to adjust their financial models to account for higher costs and potentially lower revenue streams. This is what we are going to discuss here today.

The Cost of Borrowing

One of the most immediate effects of rising interest rates is the increased cost of borrowing.

When interest rates rise, the cost of taking out a mortgage or loan increases, leading to higher monthly payments for property investors. This can diminish their ROI, as the higher costs of servicing debt eat into the rental income or profits from property sales. [2]

Investors might also find it more challenging to secure financing, as lenders become more stringent and the higher rates make loans less attractive. The increased financial burden may deter investors from expanding their portfolios, leading to a slowdown in the acquisition of new properties.

For new investors or those looking to expand their portfolios, this increase in borrowing costs can be a significant hurdle. Higher rates may limit the amount of capital available for investment, potentially slowing down the rate at which investors can purchase real estate.

Property Values and Market Demand

Higher interest rates can also affect property values and market dynamics. When interest rates rise, borrowing costs for mortgages and other loans increase, making it more expensive for potential buyers to finance property purchases. [3]

This often leads to a decrease in the number of buyers who can afford to enter the market, thereby reducing demand for real estate. As demand wanes, property values may stagnate or even decline because sellers may have to lower prices to attract the reduced pool of buyers.

For real estate investors, this environment can make it more challenging to sell properties at desired prices and could lead to longer holding periods. Investors may have to wait for a more favorable economic environment before selling their properties. [3]

Additionally, higher interest rates can affect the rental market. While higher borrowing costs might deter homeownership and increase rental demand, the overall economic impact of rising rates can lead to higher operational costs for property owners.

Investors with adjustable-rate mortgages or those seeking to refinance at higher rates may face increased expenses, which could squeeze their profit margins. They might need to pass these costs on to tenants through higher rents. However, this strategy is only viable if the rental market can sustain such increases without driving tenants away.

Rental Income and Cash Flow

Increasing interest rates can also impact real estate investors in terms of rental income and cash flow. Higher interest rates typically lead to increased borrowing costs, which means that the cost of financing property acquisitions or refinancing existing mortgages will also rise.

For investors relying on leveraged capital, this increase in interest expenses can reduce the profitability of rental properties. As a result, investors might face lower net income from their rental properties because a larger portion of their rental income will be used to cover mortgage payments. [3]

Some investors may hesitate to acquire new properties because the potential returns may not justify the higher cost of capital.

The effect on cash flow is equally critical. Real estate investors often depend on positive cash flow to sustain their operations, reinvest in properties, and cover unexpected expenses. With higher interest rates, the monthly debt service payments increase. This can in turn affect cash flow. [3]

Tighter budgets may force investors to increase rental rates to maintain their cash flow. But again, this depends on the market and tenants’ ability to afford increased rent. Higher vacancy rates and longer turnover times significantly impact investors’ ROI.

Rising interest rates can create a challenging environment for real estate investors by increasing financing costs and pressuring cash flows. This is why strategic adjustments are necessary to maintain profitability and operational efficiency.

Long-Term Investment Strategy

While rising interest rates can create short-term challenges, they also necessitate reevaluating long-term investment strategies.

In the long term, real estate investors might need to adjust their strategies to navigate a higher interest rate environment effectively. One approach could involve focusing on properties with strong cash flow potential and lower susceptibility to market fluctuations.

Investors may also prioritize markets with robust economic fundamentals and steady population growth, as these areas are likely to experience sustained demand for rental properties, even with higher borrowing costs.

In a high-interest rate environment, short-term real estate investments can be more appealing. Fix-and-flip projects, for example, can minimize exposure to fluctuating interest rates and offer quicker returns. If you take this approach, you must focus on investment properties that require minimal renovations and can be returned to the market quickly. [4]

Of course, it is also important to diversify your portfolio to include asset types that historically perform well during periods of rising interest rates, such as commercial properties with long-term leases or properties in sectors like healthcare and logistics.

Buy-and-hold residential or commercial properties may still work as long as they have strong fundamentals like location, occupancy rates, and potential for rental income growth. With thoughtful adjustment of your investment strategy, real estate investors can thrive despite increasing interest rates. [4]

The Best Real Estate Investment for Accredited Investors: Multifamily Syndication

Increasing interest rates are a double-edged sword for real estate investors. While they lead to higher borrowing costs and potential downward pressure on property values, they also create opportunities for those who can adapt and strategize effectively.

Understanding the implications of rising rates and adjusting your investment approaches accordingly will allow you to navigate these changes and get even closer to your financial goals.

For accredited investors, multifamily syndication can be a viable investment option even in an environment of increasing interest rates. However, it requires a more nuanced approach. While higher interest rates generally lead to increased borrowing costs, multifamily properties often benefit from strong demand in both rental and ownership markets.

As rising interest rates can make homeownership less affordable, more people may choose to rent an apartment or condo unit. This increased demand can drive up rental income, potentially offsetting the higher costs of financing. Additionally, multifamily syndication allows for pooling resources from multiple investors, which can further reduce risk.

A real estate syndication deal involves multiple investors pooling their funds together to acquire a single real estate property. This approach makes it easier to purchase properties that are normally too expensive or too risky for a lone investor. This type of deal can be done with any type of real estate, but multifamily syndication is the most popular among investors due to its strong, predictable cash flow. [5]

Multifamily syndication makes it easier for accredited investors to participate in larger real estate deals that would normally be out of reach. For example, multifamily properties like apartment communities and condominiums are larger, more expensive, and generally more difficult to manage. But with multifamily syndication, all of these problems are addressed.

This is because real estate syndication deals are arranged by a syndicator or sponsor who puts the deal together and executes the business plan. It is the syndicator who serves as the general partner (GP) in the deal. They are in charge of locating the investment property, conducting due diligence, looking for investors who will participate, and handling property management once the deal is in place. [5]

On the other hand, investors have limited responsibilities in the deal. As limited partners (LPs), their only task is to provide a percentage of the capital needed to acquire the property. They may also have to pay certain fees to get the syndication deal running. But beyond that, investors can just sit back and enjoy their investment, making this a true passive investment in real estate.

Through real estate syndication, investors can own a multifamily property without having to spend millions of dollars and take on all the risk by themselves. They also get to avoid all the headaches associated with being a landlord, such as handling tenant concerns and dealing with emergencies.

Accredited investors earn a share of the investment’s cash flow in exchange for their investment. Depending on the deal structure, they may also get a share of the equity upon resale. However, every deal is different. Investors should conduct their due diligence and analyze the profit split through the private placement memorandum (PPM) or syndication agreement before joining a syndication deal. [5]

Thanks to its low correlation with other assets like stocks, real estate investing is generally considered one of the safer investment strategies out there. However, multifamily syndication can be an even safer option.

Through careful selection of properties, diligent financial analysis, and effective management, real estate investors can adapt to a high-interest rate environment.

Work With BAM Capital for the Best Multifamily Real Estate Syndication Deals

Through multifamily syndication, investors get to enjoy the benefits of owning real estate, but with much fewer drawbacks. Multifamily properties are known for their consistent cash flow because they have multiple tenants and are generally unaffected by vacancies. Even if one or two tenants leave, the rest of the units can still produce consistent cash flow through rental income. [5]

With that said, even multifamily syndication has its risks. For example, investors should be comfortable with a bit of illiquidity as syndication deals tend to last for several years. This means you will not have access to your funds for a significant period of time.

Multifamily syndication allows you to acquire a larger multifamily property without buying the whole thing by yourself. However, it still requires a significant upfront investment.

This is why most syndication deals are exclusive to accredited investors. Accredited investors have the experience and knowledge necessary to assess these deals properly. They also have a financial safety net, thanks to their annual income and net worth, which can protect them in case an investment does not work out.

This is why the U.S. Securities and Exchange Commission (SEC) allows them to invest in unregistered securities.

If you want to participate in a multifamily syndication deal, it is essential to choose a reliable and trustworthy syndicator. After all, it is the syndicator that will make all the important decisions moving forward.

Choose BAM Capital if you want to work with an industry leader with a track record for excellence. This Indianapolis-based syndicator is known for its award-winning investment strategy that mitigates investor risk while creating forced appreciation. [6]

BAM Capital focuses on high-quality multifamily real estate properties that have in-place cash flow and proven upside potential, particularly those that are Class A, A-, and B++. In fact, BAM Capital now has over $700 million AUM and 5,000+ units. [6]

BAM Capital can even guide you through the entire syndication process because they are a vertically integrated company. They can handle everything, from acquiring the properties to renovating and managing them.

No investment is without risk. Make sure to consult your investment advisor or speak to a BAM Capital investment team member before making any financial decisions.

For accredited investors who want to enjoy passive income and all the other benefits of being in multifamily syndication, schedule a call with BAM Capital and invest today.

 

Sources:

[1]: https://www.investopedia.com/articles/mortgages-real-estate/08/interest-rates-affect-property-values.asp

[2]: https://www.ciro.ca/office-investor/investing-basics/interest-rates-and-how-they-impact-your-finances

[3]: https://www.straightupchicagoinvestor.com/blog/understanding-interest-rates-and-their-impact-on-real-estate-investors

[4]: https://www.sitewire.co/blog/the-impact-of-interest-rates-on-real-estate-investments/

[5]: https://multifamilyrefinance.com/apartment-investing-blog/multifamily-syndication#important

[6]: https://capital.thebamcompanies.com/