Given that the Fed is likely to keep fighting inflation, mortgage rates may rise even further after crossing the 7% mark this week. Unsurprisingly, investors should be cautious and undecided. Builder pullouts and ongoing cancellations of sales are other reasons to increase investors’ pessimism. Low borrowing rates, falling home prices, and high rental demand are perfect investment conditions. But this isn’t always the case.
According to Alex Caswell, a Wealth Planner at RHS Financial, it is rare for all stars to align because they often work against each other. Illustrating this point, Caswell says a year ago, while inventory was low and housing prices were competitive, investors could lock in a very low mortgage rate. This significantly improved their yield and required less of a down payment to invest.
Now with higher interest rates, investors need to put more down, so their mortgage payments don’t eat into their rent. However, you also have a housing market that is much less competitive now. “So it is a balancing act,” he concludes. The catch for investors has always been to buy low and sell high, but other factors are at play.
Factors That May Make Investing Worthwhile
Residual Demand and Massive Undersupply
According to Nik Shah, CEO of Home. LLC, there is lots of room for both home prices and home ownership to grow. Shah notes that millennials are entering their early thirties — the prime first-time homebuyer age — in large numbers.
They’ll jump into the market once rates cool down. According to the CEO, based on Home LLC’s analysis of 40 years of inventory data, there’s also a massive undersupply of almost one million units compared to the historical norm. “There just aren’t enough homes available for sale right now,” Shah says.
Shah argues that most housing inventory comes from existing home sales, not new construction. And supply from existing homes will keep decreasing because 90% of mortgage holders are on a mortgage rate below 5%. Consequently, most home sellers will wait for mortgage rates to fall before listing their homes for sale.
Conservative Lending Standards
“Delinquency and foreclosure risk,” Shah says, “is extremely low because of stringent underwriting criteria introduced after the 2008 housing crash.” According to CNBC, the housing market is in a healthier state than in 2007. Partly because of stricter lending laws that sprang from that financial crisis.
These regulations give today’s investors who want to borrow a much stronger foundation. Currently, just under 3% of mortgages are past due, a record low for mortgage delinquencies.
Property can be a fantastic inflation hedge because its value and rental yield tend to increase over time with general price levels. Investors can raise rents to cover rising costs such as insurance and taxes if the market warrants it. Moreover, if you prioritize cash flow over appreciation, you can use your funds to generate passive income that will remain stable for a long time despite fluctuations in the market.
“Cities with strong development activity and low home affordability may be caught out,” Shah says. According to the CEO’s analysis, Florida, Texas, Utah, and Boise are the home markets that are most likely to see a price fall because they all have decreasing demand and quickly rising supply.
Why Real Estate Is a Tough Investment To Justify Currently
Others, however, argue that now isn’t a good time for real estate investment. Kirill Semenov, a certified financial planner and an independent wealth advisor with Intellicapital Advisors, LLC, gives the following reasons:
Semenov reviews real estate investments through the prism of opportunity cost. Noting that very few asset classes are traditionally considered risk-free (mostly just treasuries). But real estate has never fallen into the risk-free category because of all the following inherent risks, which isn’t an exhaustive list:
- Liquidity Risk
- Market Risk/ Market Liquidity Risk (bear markets, high-interest rates)
- Financial/Default Risk/ Negative Cash Flow Risks
- Leverage Risk (mortgage)
- Location/ Idiosyncratic Risk (like a bad tenant or a hurricane, structural damage, roofs)
“It is widely accepted that series I bonds and treasuries have none of the risks above.” Therefore, Semenov continues, “while current risk-free investments are beginning to look more and more attractive due to rising interest rates, the investor would have to have exceptionally high growth expectations for their real estate purchase. Because they need to justify making it over investing into something risk-free (or close to it) and get compensated for assuming all the additional risks mentioned above.”
Semenov asserts that ANYTHING one invests money into currently MUST do better than 4% annually for treasuries and exceed 9.62% if compared with I Bonds. “While not out of the realm of possibility for real estate to achieve those feats with current supply and demand dynamics,” Semenov says, “it is well known that most people prefer a safe, modest return to gambling.”
According to the wealth advisor, lots of financial instruments are easy to convert into cash. Homes aren’t always that way, especially when affordability is severely hurt by increasing mortgage rates. Many areas of the country are seeing homes sit a lot longer on the market and may possibly get even tougher to sell – tilting the scales on the buyers’ side in the future.
Semenov advises, “No one has a crystal ball, but everyone should consider their circumstances, deciding if an illiquid asset could be a good addition to their portfolio.”
Alluding to Powell’s September comments, Semenov thinks it might be risky for investors to expect any improvements in the industry.
The wealth advisor notes that Fed Chairman Powell famously said less than a week ago that the focus is on bringing home affordability back to normal levels and that “…the housing market probably have to go through a correction to get back to that place.”
“Whatever your thoughts are on current policies and the Fed’s general direction,” Semenov says, “it can be risky to bet against the house.”
Semenov argues that often buying multiple properties as a retail investor also means taking on absurd levels of leverage (huge mortgages) to achieve diversification. Especially with the high rates where the average home sold in the US goes for over $400,000.
And even tougher now with higher interest rates of over 6% for a fixed 30-year mortgage in most places. “I have seen some of my clients attempt this high-leverage gamble against any and all advice, and I cannot justify that as a sustainable investment strategy,” the wealth advisor concludes.
The decision of whether to invest or not isn’t straightforward. Investors must perform their due diligence on the transaction and confirm that the property generates a profit. The days of buying a property with a cash flow break-even point in the expectation of making money on it right away are long gone. Using less leverage on present deals is one method investors may use to lower risk.
If you decide to invest, keep an eye on the market to seize potential opportunities. Investors need to emphasize the safest purchase that can help generate a higher return over the long term in this dynamic housing market. Real estate investment trusts (REITs), which are significantly impacted by inflation and frequently outperform during times of high inflation—thanks to robust income returns that counteract declining REIT values—are another option for investors. They offer chances for long-term growth.
More Articles From the Wealth of Geeks Network:
- 12 Best States For Real Estate Investors And What Factors To Consider
- How To Set Financial Goals and Achieve Them: Step-by-Step Guide
This article was produced and syndicated by Wealth of Geeks.
Amaka Chukwuma is a freelance content writer with a BA in linguistics. As a result of her insatiable curiosity, she writes in various B2C and B2B niches. Her favorite subject matter, however, is in the financial, health, and technological niches. She has contributed to publications like ButtonwoodTree and FinanceBuzz in the past. In addition to ghostwriting for brands like Welovenocode, Noah and Zoey, and Ohcleo, amongst others. You can connect with her on Linkedin and Twitter.