As Al Pacino famously said in The Godfather III, “Just when I thought I was out, they pull me back in!”
Just when you thought you’d seen the end of high interest rates and that the Federal Reserve’s hand-picked new chair, Kevin Warsh, had a clear mandate to lower them, news of the Fed’s quarter-percentage-point rate hike has all of us investors shuttling back to 2022 in a nightmarish fever dream of negative cash flow. Will it never end?
A quick recap: Amid rising inflation sparked principally by the Iran war, the Federal Reserve raised interest rates for the first time in three years after its September meeting. For many investors, that will only add insult to injury because, at the time of writing, mortgage rates have already moved above 7%, so another rate hike will only add fuel to the fire.
However, for small investors looking to grow their portfolio, the obvious silver lining is that higher interest rates could lead to falling prices. For those with capital, the chance to nab a deal amid low competition and high rental demand is a golden opportunity.
Before we get ahead of ourselves, remember that the Fed does not directly set mortgage rates, which are more closely tied to long-term bond yields, inflation expectations, and demand for mortgage-backed securities. This helps explain why interest rates have been rising even though the Fed has not raised them until now.
However, the Fed’s actions affect interest rates indirectly, and investors should keep in mind that mortgage rates will not necessarily rise or fall by the same amount as the federal funds rate, which is what the Fed’s rate changes directly correlate to.
A Sequel Many Times Over
We’ve all seen this movie before, only with different actors. First were Jerome Powell and Joe Biden, then Powell and Trump, and now Warsh and Trump. Despite the changing actors, the script is largely the same, and the outcome—the difficulty in getting leveraged rentals to cash flow or buyers to qualify for flips—remains.
“For buyers, a slower market can actually create opportunity,” mortgage executive Benjamin Cohen told Realtor.com. “There is more time to make a decision, more negotiating power, and potentially more flexibility from sellers.”
Not Every Housing Market is Slowing at the Same Pace
In addition, the housing market is not monolithic. According to Realtor.com, the Midwest offers fertile hunting ground for deals, with August pending sales down 4.3% from a year earlier. Pending sales were down 3.3% in the West. However, the same number is up 1.8% in the South, and the Northeast is up 1.1%, so deal-getting is very much a state-by-state scenario.
Prices also swing widely, with price reductions in the Northeast affecting 14.15% of listings, compared to over 20% in the West and South. So, in addition to the Fed’s move, investors will need to calculate potential cash flow based on negotiating power, along with all the usual metrics such as insurance, taxes, and rents.
That said, a Fed rate hike will have a major effect on all U.S. housing markets, as many retail owner-occupants will be eliminated from the discussion.
“Historically, rates are not that high, but we are also at the highest prices ever seen in many markets, so having rates this high on top of record high prices, we noticed that just going from a 6.75% rate to a 7% rate, it takes out a swath of buyers,” said Beau Keenan, broker-owner of Dickson RealtyKeenan, in a recent HousingWire report on market sentiment.
Cash Rules Everything Around Me
The Wu-Tang Clan’s hip-hop classic, “C.R.E.A.M. (Cash Rules Everything Around Me),” has proven more prophetic than even the rap legends could have imagined. For cash-ready buyers, rate hikes and falling prices are where fortunes are made. The extended homebuying malaise has opened pockets of real opportunity, with many motivated investors keen to take advantage.
“A lot of our buyers are coming in with equity from a home they just sold, or they’re paying cash outright, so a hike isn’t going to keep them away,” said Anna-Marie Ellison, vice president of sales at John R. Wood Properties Christie’s International Real Estate, to HousingWire, emphasizing how cash reserves and equity insulate top investors from rate movements.
There are several ways to access the cash you need to buy, even if you don’t have it sitting in your bank account:
- Sell assets (stock shares or other nonperforming real estate).
- Partner with a cash investor.
- Borrow from a family member at a low rate and refinance when feasible.
- Look for small multifamilies that you can house hack with an FHA loan.
- Look for seller financing opportunities or assumable mortgages.
Rental Demand Remains Strong, Urging an Investor Response
The increase in interest rates is a double-edged sword for investors. On one hand, conventional leverage investing, including BRRRRs, will be made more difficult. On the other, it keeps homebuyers out of the market, heightening rental demand and making purchases more likely to be absorbed quickly at maximum rents.
This is reflected in recent data from the Federal Reserve Bank of New York, which shows consumer inflation expectations and rent growth remaining firm, reflecting the continued housing demand across urban and suburban markets.
Use Long-Term Cash-Flowing Rentals to Upgrade
For landlords who own long-term rentals and are locked in at low interest rates, as tempting as it is, now might not be the time to try creative borrowing strategies to buy more deals. Instead, using the cash flow from your existing rentals to make upgrades might be the safest and ultimately most profitable way forward. Stabilizing buildings with long-term, reliable tenants is far less risky and stressful than jumping into a turbulent real estate market, despite the temptation to do so.
Final Thoughts
For owners with multiple property portfolios who have been keen to keep stacking doors, now might be the time to take your foot off the gas and evaluate what you already have, what is working, and what’s not. If you were hoping to refinance high-rate loans by now but haven’t been able to, using cash flow to pay down balances, or—if you are unable to maintain some assets at a loss—selling and taking a haircut to preserve a smaller but healthier portfolio and lessen the day-to-day stress could be a good strategic move.
You can always live to fight another day, but life is short, and in the rush to get rich, it’s worth remembering to enjoy the journey, not just fixate on the destination.
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