Mar 14, 2023
Do High Interest Rates Make Turnkey Homes a Bad Investment?
Real estate investors in the US have one distinct advantage over rental properties in other countries—the 30-year fixed-rate mortgage. The interest rates on these mortgages are often meager enough to offset the cost of borrowing.
They also eliminate the risks posed by unexpected interest rate raises down the road. But what happens when the unexpected happens, and the interest rate spikes to an unexpected level? Do high-interest rates make turnkey properties a bad investment?
The answer is a resounding no! You shouldn't stop investing in turnkey homes because high-interest rates take a bite out of your cash flow.
Turnkey Homes are a Long-Term Investment
You must remember rental properties are long-term investments whose profits are spread over the long haul. When analyzing a rental property's finances, it is only natural to focus on the current cash flow numbers. However, you must remember that projected cash flow doesn't account for several significant factors. These include future rent increases, demand, appreciation, and inflation.
Ideally, building a solid understanding of how rental properties work and make money helps paint a clear picture. It offers insights into the factor you can control, profits, and what to look for when picking your next rental property. Accounting for these factors can help you maximize your returns despite the higher mortgage payments.
Effects of High Interest Rates on Real Estate Investing
From an investor's perspective, high-interest rates are a blessing in disguise. They make the homes less affordable, which makes the rental market less competitive. Higher demand improves investors' cash flow and helps them maximize their ROI. However, the soaring prices lower the chance of snagging a great deal, forcing you to dig deeper into your pockets.
Rather than contend with the high-interest rates, you may choose creative financing when purchasing your next turnkey property.
What is Creative Financing?
Creative financing refers to unconventional ways to raise money to purchase a property. They help real estate investors bypass costly conventional mortgage loans driven by high prevailing interest rates. Typical forms of creative financing include seller financing, ARM mortgages, and subject-to.
Seller Financing
Also known as seller carryback, seller financing works when the property owner agrees to hold a note of purchase. The buyer pays a monthly payment until they've paid off the note. It's a great way to finance a purchase with other people's money. Use this toolbox to seize a great investment opportunity that may require refinancing down the line.
Adjustable Rate Mortgages (ARM)
These loans have variable interest rates and offer interest-only payments during the initial term. The initial interest rate is fixed for a given period—it could be a year, 5 years, 7 years, or more. After the fixed period, the interest rates reset yearly or monthly. Investors will often finance initially with an ARM loan, then refinance to a 30-year mortgage prior to the interest only payments expiring. This allows the investor to make a lower monthly payment during the ARM loan period as well as once they refinance, which creates positive cash flow.
Subject-To
This form of creative financing allows you to take over the repayments of an existing mortgage. With a 'subject-to' transaction, the mortgage remains in the seller's name, but the buyer assumes ownership and makes mortgage payments.
Protecting Your Cash Flow
The average real estate investor knows that rental properties are highly lucrative, but they need to understand why or how they are so profitable.
Typically, rental properties have four profit centers, namely:
- Appreciation
- Cash flow
- Tax benefits
- Equity building
Building a solid understanding of these profit centers clarifies the value of long-term investing over the short term. It can help you realize that servicing a mortgage that's a couple of points higher pales in comparison to a turnkey property's lifetime profits. If the cash flow is lower than expected, you proactively ease the situation. You can refinance the property at a lower rate down the line to reduce the mortgage payment and increase your profit margins.
Alternatively, you can find efficient ways to balance the profit centers and ensure the higher mortgage rates don't lower your cash flow. Prioritizing demand and location when buying a turnkey property allows you to charge premium rental rates and maintain a positive cash flow from the outset.
Working with a skilled professional can help you pick the best turnkey properties and maximize your ROI.