A mortgage with a fixed interest rate for the first thirty years of the loan’s term is one of the most helpful financial instruments available to investors in rental property in the United States. Interestingly, this kind of loan differs from what is generally available in other nations. Most nations provide loans with flexible, fluctuating, variable, or renegotiable interest rates. Each of these types of mortgages has an element of risk since there is always the potential that the interest rate will increase unexpectedly while the owner is in possession of the property.
Fixed-rate mortgages are not only helpful to investors because they enable them to avoid potential rate increases in the future, but they also provide other advantages. However, there have been significant periods of time during which the rates of interest on these loans have been astonishingly low. As a result, the cost of borrowing money has been remarkably little at these times.
It remains to be seen what will happen if interest rates rise above what we are familiar with. The monthly payments for our mortgage have all of a sudden been significantly increased, which has a negative impact on our cash flow returns. What does this indicate for my decision to continue investing in rental properties? Should I cut down or quit altogether? What steps can you take to ensure that you continue to generate a profit from your rental property even if your interest rates on your mortgage continue to rise?
The most effective technique to conclude this issue is to understand the financial potential of rental properties. The aspects of a rental property and its profitability that are within your ability to influence, as well as understanding what to search for in a possible rental property, may help you position yourself for the highest possibility of profitable returns, despite the increased monthly mortgage payment.
Investing in rental properties is a long-term plan
One of the most important things to keep in mind about rental properties is that they are, in reality, assets with a long-term horizon. Certainly, some individuals may see a rapid equity profit via renovations or value-adds, and others may find transactions with big cash flow from the beginning. However, most people do not experience either of these outcomes. However, it is important to keep in mind that, on average, rental properties bring in the most money throughout an investment’s life.
When doing a financial analysis of a rental property, we often focus on the cash flow statistic immediately in front of us. It’s easy to overlook that today’s expected cash flow is only a forecast. This figure does not consider factors like rent increases over time (while maintaining a steady mortgage payment), value, demand, or inflation. There will be consistent changes in each of those elements, which we anticipate will be improvements.
An overview of how renting a property generates income.
Before you learned about real estate investment, you may have been aware that rental properties can be quite valuable, but you might not have fully understood precisely how they might be so successful.
There are five different strategies by that rental properties might generate income, and they are as follows:
- Cash flow
- Equity built via mortgage paydown
- Hedging against inflation
- Tax benefits
When you deeply understand the particulars of each of these profit centers, you will not only be in a better position to appreciate the potential benefits of keeping a rental property for the long term rather than the short term. However, you will also start to understand that the cost of a rate of interest that is a few points more than what you are used to probably does not even come close to competing with the potential profit that may be made from the rental property over its entire lifespan.
You may already think, “However, these other revenue centers are risky, cash flow is still crucial, and the greater mortgage expenditure raises my risk by decreasing cash flow.” Yes, and there is a good chance that’s the situation. However, there are two things that you should focus on doing in this situation:
- Understand how to manage the profit centers. If you are seeing a drop in cash flow, which is normal when the interest rate is increased, you could look for additional profit centers that have undiscovered potential. You may be purchased in an area now experiencing gentrification and seeing strong demand; if this is the case, you might assume that the potential for appreciation is quite high. Or maybe you are making investments at a period of very high inflation. In such a situation, what options do you have? Imagine this as a bar graph, with a separate bar representing each profit center. If one has a problem, do any of the others still work? If every single one is out, we have a problem. If some are more than normal, do the others compensate? All of this is dependent on your specific scenario.
- Pay close attention to location and demand. In the same way as with that particular example, one of the secrets is to make investments in real estate that will specifically give their hand to the appreciation bar, in addition to inflation and rent demand. As long as there is demand for the real estate that the proprietors own, the potential for financial gain generated by the profit centers will be much higher, and they will continue to expand in scope over time.
When you understand how income is generated from rental homes, you can switch from thinking of yourself as a consumer to thinking of yourself as an investor. Those are led to believe that higher interest rates are deal-breakers because they are wearing the consumer hat. However, people who actually grasp how rental property earn will not only come to see how to see beyond the interest rates but will also provide them insights on how to pay for it.
As was previously said, the expected cash flow of a rental property is calculated based on the rentals received today, not those collected tomorrow. There are two main drivers behind rent increases: appreciation and inflation.
Try to guess what does not rise with time and is unaffected by changes in the currency’s value or the appreciation of its value. A fixed-rate mortgage payment is exactly what you’d expect it to be.
This indicates that your cash flow spread will continue to expand throughout the life of your rental property, provided that you continue to raise the rentals.
Your costs, like property tax and insurance, could go up over time, but it’s doubtful that they’ll increase at a pace that matches what rentals will do. In general, you’ll see that rentals will continue to draw farther and further away from your fixed-rate mortgage expenditure, and your earnings should expand exponentially. This is a good sign.
Increasing Profitability and Minimize Expenses
Although I’ve been focusing on the long term, proactive steps can be taken to generate greater wealth in a shorter amount of time. Let’s go through each one of them.
Increasing the value of the house
Your home will earn more worth and attract a greater level of demand the more appealing it is. You can add things to your property to improve the attractiveness and drive those profit gains to occur more rapidly. While many revenue centers will kick in on their own over time, raising the value of a property and the rentals, you can also enhance desirability by doing things.
Rehabilitating an older home or building is the primary technique for boosting the value of a property. You raise the total worth of a property by improving it so that it is nicer and more appealing to potential tenants, and you also give yourself the opportunity to ask for higher rents on that property. You are not really increasing your earnings; rather, you are just accelerating them beyond the point when the rise in interest rates is costing you.
You should keep in mind that the higher interest rate you’re paying now may not remain the case indefinitely. Mortgage interest rates are open to a similar range of motion as property prices and rental rates. You can re-finance the home at the new, lower interest rate if the interest rate falls below the one you were initially committed to paying. Obviously, there is no assurance that the interest rates will decline, but if they ever do, you will be able to implement this change and see an improvement in your company’s cash flow.
Choosing a suitable place
If you’ve been paying attention, you’ll have realized that the topic of discussing the location of a rental property isn’t new. You may make even smarter decisions when you understand how to assess neighborhoods and select locations with an incredibly high likelihood of appreciation. This is similar to what was said before about purchasing in a demanding route to assure profitability ratio. Values might go up due to changes brought about by gentrification, population expansion, and job growth.
However, as with any other appreciation, relying on gentrification is speculative at its core. You should not only educate yourself on how to recognize neighborhoods that may undergo gentrification, but you should also prepare a backup plan if gentrification does not occur in the neighborhood in question. You shouldn’t put all of your financial security on a single profit center since there is always the possibility that it might collapse. Nevertheless, gentrification may result in increased profits; however, this is contingent on the buyer making their purchase at the optimal time, which sometimes necessitates acting swiftly and avoiding excessive hesitation lest they miss out on the opportunity.
Overcoming Inflationary Pressures
Even though inflation generally negatively influences most aspects of our life, there is one area in which it might be beneficial: the rental market. Regardless of what happens to the dollar’s value over the loan term, your monthly expenditure for the fixed-rate mortgage will remain the same. You have to make the payment in the same currency as the loan, not the currency of the day after tomorrow.
Inflation against mortgage interest rates is a good comparison point. As a result of inflation, the cost of purchasing an identical home with cash in today’s dollars would be more than the cost of paying the mortgage interest on a 30-year fixed mortgage throughout the loan’s duration. This is the perspective of many industry professionals.
As long as inflation rises quicker than the interest rate on your mortgage, you’ll continue to make more money than you’re spending.
The Basics to Remember
If you read this post, it would be simple to conclude that if you keep a rental property for a very long time, you will make a lot of money off it. This would be the case, although your current costs may be more than they were in the past since eventually, everything will catch up and turn into a profit.
This is not going to be the case with all of the houses. There is no assurance that any investment in rental property will result in a profit, and various circumstances might undermine certain profit areas. It is also crucial to keep in mind that conjecture does not always play out, and the best course of action is to steer clear of speculation as much as possible.
This article’s objective is not to deceive you into believing that any property can be turned into a lucrative investment. Rather, the purpose of this piece is to demonstrate how to look at and evaluate possible rental properties while keeping in mind that a higher interest rate won’t consume as much of your income as you would believe it will.
Having a good education is also very significant. For example, a rate of interest that you consider exorbitant could be considered “average.” We have become used to the sight of interest rates that are at historically low levels. Because of our privileged background, we are under the mistaken impression that the only way for us to make a profit on our mortgages is if the interest rate is exceptionally low.
Last but not least, if the interest rate continues to be a source of concern for you, you can consider making a larger initial payment on the loan so your monthly payment can be lowered. In addition, if you make a larger down payment, you can be eligible for a lower interest rate.
If you’ve made investments when interest rates were higher, what was the most innovative financing arrangement you employed on your rental properties during those times, and how did it play out 10 or 20 years after you owned your property?
Financing for Rental Property Investing
New City Financial has over 10 years of Rental Property Investing mortgage lending and Rental Property Financing as well refinance options to help you grow your rental property investment portfolio. Contact us if your looking for a Rental Property Mortgage Loan or Commercial Property Refinance. You can also call them at (855) 848-2862.