Rental Property Café™: Episode 13: 4 Questions About the Impact of Rising Rates

In this episode, Cynthia Meyer and Veronica Woods discuss the impact of rising rates on real estate investors.

In this episode of the Rental Property Café Video Podcast they cover:

Takeaway Quotes:

“Real estate as part of your overall investment portfolio is a hedge against inflation.” - Cynthia Meyer

“The upside of the rising rates is that the demand for rentals is really strong.” - Veronica Woods

About the Rental Property Café™: 

The Rental Property Café™ podcast offers a real estate tool kit for busy professionals who are building a real estate portfolio. In each episode, co-hosts Cynthia Meyer & Veronica Woods explore ways to grow a successful real estate business while growing your career.

☕ See more financial planning guidance for real estate investors from Cynthia Meyer on the Real Life Planning blog: https://reallifeplanning.com/blog

About Cynthia Meyer

Cynthia Meyer is a financial mentor, CERTIFIED FINANCIAL PLANNER™, CFA® Charterholder, real estate investor, blogger, and the founder of Real Life Planning. She offers unbiased financial planning and learning resources to real estate investors. Cynthia is a first-generation rental property owner, who built a rental property portfolio with her husband, Steve, while they were both building their careers. She lives in NJ, where she balances teenagers, her financial planning practice, and a rental property business.

About Veronica Woods

 Veronica Woods of Daniel Woods Real Estate, real estate advisor and investor, is passionate about helping her clients create wealth, legacy, and lifestyle through real estate. She works with people to buy, sell, rent, and develop residential and small commercial real estate in Delaware County and Philadelphia, PA. An MBA in finance from the Wharton School, Veronica also shares her real estate wisdom with new investors on her YouTube channel. 

Connect with Cynthia Meyer:

• Cynthia on Facebook
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• Cynthia on Pinterest 
• Follow Cynthia on Duolingo: CynthiaCafe
• Email: cynthia@reallifeplanning.com   

Connect with Veronica Woods of Daniel Woods Real Estate:

• Veronica Woods - Let's Connect

Transcript -  Rental Property Café™ - Episode 13

[00:00:00] Cynthia Meyer: I've been getting a lot of questions in my financial planning practice about the impact of rising rates on real estate investors and on people who are thinking about selling their properties, as well as people who are thinking about buying their properties. Veronica, I'm guessing you're getting a lot of these questions too.

[00:00:15] Veronica Woods: Yeah, just a lot of uncertainty and wanting to not make a mistake. Really nervous about jumping into the market. Is this still the right time considering that? 

[00:00:26] Cynthia Meyer: Yeah. So that's why today, in episode 13 of the Rental Property Café, we're diving into some of those questions, in particular, the four most common questions that we've both been getting lately about the impact of rising rates. 

[00:00:48] Cynthia Meyer: Hi, I'm Cynthia Meyer with Real Life Planning and 

[00:00:51] Veronica Woods: I'm Veronica Woods with Daniel Woods Real Estate. 

[00:00:53] Cynthia Meyer: And this is the Rental Property Café,. So the first and most common question that I'm getting from folks is, " Hey, I'm a real estate investor. How does inflation affect me right now?"

I'm interested. What do you tell people when people ask you that question? 

[00:01:09] Veronica Woods: I start by telling the people who currently are investors, "Hey, you're in a great place because real estate is one of the best hedges for inflation." If you took your $200,000 property to value and you put it in the bank, you lost money this year versus you're so much more protected having your money in a real estate asset.

[00:01:33] Cynthia Meyer: Yeah, and I agree with you. Real estate as part of your overall investment portfolio is a hedge against inflation. In general, historically, both the value of the property and rents have gone up in a correlated or in tandem with inflation over time. And so it can be as part of a diversification strategy. It can be really great hedge against inflation. Securities typically go down in a high inflation environment. So it's nice to have something in the portfolio that might be going up. 

[00:02:05] Veronica Woods: For our friends who bought real estate, let's say in the last two three years, when rates have been in at a all time low and you've got fixed rates, you are locked in with that payment despite everything that's going on right now. Despite the stress of the cost of running your real estate business going up, you have this fixed rate locked in. Now, what I tell them is you have to do a good job of managing planned inflation or rises in rents because that doesn't happen automatically. Once you get a tenant in a property, you have to look at what your lease says. Making sure your complying with what your local municipality says about how the process of raising rents. Because it is a process. That's really what your focus needs to be. How can you make sure that you're continuing to raise your rents year over year? 

[00:02:57] Cynthia Meyer: And as a best practice, I often talk to people about setting a goal for themselves of raising rents 3 to 5% a year on the average, if that's allowed in the local jurisdiction. Obviously the market doesn't always bear that. But in the years where it can, just having a systematic process for raising rents a small amount, every time the lease comes due can be very helpful. It's a balance between keeping the unit occupied and raising rents on an existing tenant. It's a judgment call for the investor, or for the property manager, who's working with the investor. Rents don't raise themselves. So for real estate to keep pace with inflation the real estate owner, the rental property owner, has to have a plan to systematically raise rents over time. And your costs are going up as a landlord. So everything is going up. The costs of labor, the costs of materials, et cetera. Your property taxes are generally going up. That's all going up too. So in order to keep a profitable business you do have to raise rents over time, over a long period. 

[00:03:55] Veronica Woods: Yeah. And like you said, I think there is an art to communicating the realities. The tenants are facing the same inflationary environment too, with their groceries and gas and everything.

[00:04:09] Cynthia Meyer: Yeah.

[00:04:10] Veronica Woods: So, they understand why, but you just have to communicate it and like you said, keep making sure that you're in compliance with your local municipality. 

[00:04:19] Cynthia Meyer: That's right. And thinking about, and again, it's a judgment call, but thinking about being fair, right? If you have a good paying tenant, who's keeping the unit in good condition; balancing that against the fact that you are trying to raise the rents to current market rates.

And it's a judgment call, right? It's a judgment call that you have to make is an investor. And the other thing I meant t o point out that is a conversation I've been having frequently with people is that it's very difficult to BRRR in a rising rate environment. And so BRRR for those people who are not familiar with that acronym is, Buy, Rehab, Rent, Refiance, and Repeat..

But if you are refinancing a property like Veronica and I talked about in episode 12, you're refinancing it at a higher rate. The property might not be cash flow positive anymore. So it causes investors to rethink whether they're going to do a cash out refinance particularly if it's in a highly appreciated property and they've already cashed out and refinanced it once already. 

[00:05:14] Veronica Woods: We can jump into the second question which is you're looking for a new property listing. So let's say you're approaching, buying your next property or your first property, what does rising rates mean for you?

[00:05:28] Cynthia Meyer: My gosh. What an important question. Because I think we're all asking ourselves, especially those of us who are investors during the great recession in 2008 to 2012, i s: are property price is going to go down enough that I might want to wait before I buy something?

I've got capital now. I want to take advantage of the inflation correlation of real estate. So maybe I want to buy right now, but maybe my budget isn't as big because I have to mortgage the property. So really running the numbers. Running the numbers and making sure that the property is going to be cash flow positive before depreciation, so that you don't have net carrying costs out the door for the property is going to be really important. 

[00:06:11] Veronica Woods: Yeah, I do think it's important for those folks who either you were in that environment, post a great recession, or you hear stories of that; let it go. It's 20 22. You do have to run the numbers, but as far as calibrating what's a good deal or not, it may look a little differently, especially if you're in it for the longer term. You're not in it for one year cash flow. If you're only in it for one or two years, this probably may not be a rental property; may not be your investment vehicle. But the upside of the rising rates, if there's an upside, is that the demand for rentals is really strong.

So I tell my clients like you are meeting an unmet need for affordable housing in these areas. If you can figure out how to solve the problem, just like any other entrepreneur, like there is a demand. I do think we all have to be more creative about how to get that demand and pull it off. The demand for rental housing in most of the country is pretty strong right now because there's a affordability crisis. There are legit people priced out of the bottom of the market. They just can't afford to buy. So they're going to have to rent longer. 

[00:07:25] Cynthia Meyer: Right. And that pool of people has gotten larger as rates have gone up in what might have been affordable with historically super low interest rates at the bottom of the pandemic. Now those rates are so much higher. People just can't get into the market at current rates. 

So lots of people who are listening may have bought their first house at six, seven, or even seven and a half percent interest rates. People who were around in the late 1970s and eighties might have had even at a higher rate when they bought their first house. And one thing those people have probably done over time is refinanced multiple times. If you are getting into a property and it's you know, marginally cash flow positive. Hopefully, it doesn't have negative caring costs. And with the idea that, okay, when rates go down half a percentage point, 50 basis points or more in the future, you're hopefully going to refinance that loan at a lower rate.

[00:08:17] Veronica Woods: You have to manage the financing, just like you're managing the stuff about the tenants in terms of looking for opportunities to improve your cash flow. You know what I'm hearing from talking to lenders who work with investors, that think about the average investor, is refinancing between every five to seven years.

So generally in, in your head, you should think about, even though you're getting a 30 year fixed rate, you're not going to probably keep that same loan for the entire period that you own the property and be able to take proactive steps to be able to make that happen; which leads me to my other point. I think that some of us may need to upgrade our lenders. So maybe the lender, they just threw up a softball at the two and a half percent. It sounded like a great deal. And maybe you were paying extra in points and costs, but it just made sense. Now, I think I'm having different conversations when interviewing potential lenders. What products do you see working now? They're innovating. They're talking about now we're seeing more investors using this product or that product. So if you're just having a rate conversation with your lender, you maybe have a less sophisticated lender that work with investors. So I think it's a time now to really, like you said, revisit or upgrade the lenders you're working with. 

[00:09:39] Cynthia Meyer: That's a really great point, Veronica. As we've talked about before, a really good lender can be a partner in helping you evaluate a deal. Helping you figure out if it makes sense or not, and is going to be asking you questions through the lending process that are going to help you make better decisions about your investment.

The third question that we've both been getting a lot is from people who are considering selling a property right now. How do higher rates impact sellers of properties? 

[00:10:06] Veronica Woods: The first thing, a s a realtor, I work with a lot of folks that are actively selling properties. Trying to figure out what the asking price should be. And because the market's been so hot, a lot of people just been throwing stuff out there and seeing, if they can catch a rainbow or continue to hold on to the bullish market. But now with that pricing pressure that the buyers face, the sellers have to realize; can people afford to finance the purchase to give you that price? Because of the value equation of the rates go up, without the income going up, the value goes down. So I think it's important for sellers to realize the constraints that buyers are facing from income producing properties or even single family properties of people just cashing out or being like, pushed out of the market because of the rising rates.

[00:11:04] Cynthia Meyer: I would say that there is less negative price pressure on what you might call the starter home or the single family home because there's higher demand in that space. There's still a huge gap between the number of household formations and the available housing stock that's in inventory right now. And there's competition from investors, especially cash investors in that space. But I am seeing on both the more luxury properties and on the larger multi families that has been very interest rate sensitive. So somebody that could, for example, buy a one and a half million dollar property before at lower rates is not going to spend that much on, you know, a million dollar plus property right now.

[00:11:47] Veronica Woods: So I know we're the Rental Property Café,, but to my clients that are fix and flippers, the whole point of their buyer, the retail buyer, first time home buyer. And if they can't afford the same monthly payment, then the numbers don't work for them on the other end. So the flippers are definitely impacted just by something as, obviously you want the appraisals, and that's a whole other element, but, wishful ARV thinking is one element. But the ability to find someone who wants to have their forever home in a certain neighborhood and what their economics are, I think it does matter.

[00:12:27] Cynthia Meyer: For somebody who is in the multi-family space, for example, or in some other kind of commercial investing, thinking about the concept of the discount rate is important. So the discount rate is the rate at which an investment project becomes profitable. If the interest rate that you're paying on the financing is higher, by nature, the discount rate is higher. And that means that the initial amount that you would put in equity in a project is going to be lower. I had an example with a client recently who was looking to buy a commercial property that had a very specific use. It wasn't a property for everybody and they've been in negotiation for several months with the seller. Initially when they started negotiating, the rates were at 3.5% and now the seller is asking for almost double that. He's just not going to get it the same price at double the interest rate for it.

[00:13:21] Veronica Woods: And you could see through an analysis example of a deal I was evaluating with a triplex recently. Last year, the numbers with the cash flow, they would've been like a no brainer for my client. We can get financing. But with the rates jumping, let's say from four to six, there was only so much upside in the rent. So what we were talking about earlier in terms of managing increases in rents over time, there's something to be said where you can't just take a property in a certain location and wish that it was in you know, ascribe the rents for a total other location. 

So in Philadelphia, I made the analogy to the listing agent: "Hey, this isn't Ritthenhouse Square. So we only going to raise rents by this much. The numbers don't work at the current interest rate." So it's a whole conversation. And interestingly enough, the listing agent did adjust the price down by about $50,000 after that conversation, because I told him of the conversation I had with a potential lender and of what they said and the number's not working. They adjusted their price which is what as a seller, you want to get ahead of just understanding what your potential buyers; well, how they're running the numbers and what their scenarios are going to look like so that you can put a price out there within range of reasonableness for somebody that has the means to buy your property. 

[00:14:48] Cynthia Meyer: Yeah, that's certainly an important thing to think about. And what about people who might want to sell their properties in the medium term future, but are asking, " Should I sell now? Should I sell now before interest rates go up again?" for example, is a common question that I'm getting with those folks that I'm working with who are, have developed an exit strategy for their properties but they're not ready to get moving on it just yet.

[00:15:15] Veronica Woods: Yeah. Ithe point I made earlier about, we talked about the hedge for inflation, so you're going to see a, especially if you have a great interest rate, so you're going to sell from an asset that you're protected with and then what are you going to do with the money? Now, if you have an alternative investment that makes sense.

If you're going to take that money and put it in a bank, obviously with the inflation going, that's not really the best decision. 

[00:15:39] Cynthia Meyer: Yeah. 

[00:15:40] Veronica Woods: But if you have an alternative, then maybe it makes sense. But I do think that we have to, I find myself reminding my clients that it's a long term gain.

 So even if you're, let's say you're taking a hit in cash flow in a short term. Most of us are and I'm an investor too. I sometimes I forget to interject that on the cost. So I see the reality of the cost going up and you really can't just hike up the rent, especially unless if it's vacant, then you have the opportunity.

So, you know, for this fixed period, maybe everyone's cash flow is constrained. But you're looking the long term. So you're looking at where you'll be 10 years from now. What you can do with, what that asset will be worth. And so I would remind them of that's why they bought it two years ago, five years ago, was for the long term. 

[00:16:30] Cynthia Meyer: So not necessarily speeding up the decision to sell just because of interest rate moves.

In other words, keeping, thinking about keeping real estate through the entire real estate cycle, which is longer than, and slightly different than the regular business cycle. 

So interestingly, in our rental property business, my husband and I we'd been on this kick where we were trying to increase our number of doors. So where we had highly appreciated single family homes that had come up for rent when we had a vacancy. We've been thinking about, "Oh, can we sell that property?" Lock in the appreciation and do a 1031 exchange to something with either a small multifamily four doors or less, or in one case, a small apartment complex.

For us now, the higher rates just didn't make sense. So we recently had two properties that became vacant; two single family homes and we decided we were just going to spruce them up a little bit; put them back on the market in a month and hopefully lock in those new higher rents. 

[00:17:28] Veronica Woods: You' re describing a lot of the average investors, especially maybe not with our professional help like ours, are not really thinking about evaluating the portfolio over time. What makes sense as you're diversifying; have different types of assets or maybe even different markets. Maybe you can, it makes sense to reallocate where you're investing your real estate. But it's still in real estate.

I think that's the important thing that you just said. You weren't saying take out the money and put it in the bank. You were saying sell the one asset to reinvest in maybe an asset that could maybe yield more. So that definitely takes time. And that is really part of the job as an investor to evaluate that. 

[00:18:15] Cynthia Meyer: That's right. Having worked with so many investors over time, now is this period in history where investors who are not cash buyers really have to get a little bit more creative. Both in thinking about what kinds of deals they're going after and how they're going to structure the deal with their lender, for example. But this is the time where really being smart about what you do can have a huge impact on your total portfolio later on. 

[00:18:42] Veronica Woods: Yeah. And I also think that if you can get in and be cash flow positive. Might be a little lower. I just think the longer term, if you're able to take advantage of the deals that are out there and they are still out there.

So the deal I was talking about before, is not that there wasn't a great deal ready to sell, but it is just, you had to be more creative about the financing and I just reiterate the point of yeah, with right lender that can help you pull off that deal. The other thing that we didn't mention is, maybe as a seller, considering financing a buyer. And as a buyer, considering asking for that from a seller, if the seller doesn't really need all the money at once. Having the seller hold a note for a short period of time in this high interest rate environment, maybe something feasible to make the deal work. But everyone has to be open to having that conversation; figuring out how to structure that part of the deal.

[00:19:42] Cynthia Meyer: That's right. And if you're an investor through an entire real estate cycle, you can think about market conditions; the cost of borrowing. You can think about all those things like weather. So how are you going to go out dressed for the weather? Are you carrying your umbrella? Are you wearing your big down parka? If you're an investor for the long run, you will have ups and downs in the market cycle. There will be ups and downs at interest rates. There will be expansive inventory and a contracted inventory. That's all part of the weather around being a real estate investor.

Although we're not quite in a recession yet, in my opinion. If we are headed for a recession, thinking about maybe this is a good topic for a future podcast, because recessions are opportunities for people who have a strategy. So if they're consistently saving cash from their net rents to buy a new property. If they have other income, like they can use for investing in recessions, that can be an opportunity to add strategically to the overall portfolio.

[00:20:41] Veronica Woods: Agreed. 

[00:20:42] Cynthia Meyer: So Veronica, anything else that you want to weigh in on about these questions that we've both been getting from real estate investors about the impact of rising rates? 

[00:20:51] Veronica Woods: No, I just really, my first point, real estate is a really great hedge for inflation and following what the wealthy are doing about protecting themselves and building assets on the balance sheet, that's what we all should be striving to do. And I love the weather analogy of just maybe you need a different tool, but doesn't mean that you don't go outside. You just prepare differently. 

[00:21:19] Cynthia Meyer: Oh, I love that. Let's end on that wonderful note. So as usual, Veronica, it's been so great to talk to you on the Rental Property Café, this morning. I look forward to our next conversation in this series about running your numbers. In our next call, we're going to be talking about the role of appreciation.

In the meantime, if you found this topic interesting go back and look at episode 12, where we started our discussion about the impact of rising rates on cash flow and check out the other videos in the series for more rental property tips.

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