Tips For Lending During a (Possible) Downturn
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Loading... - Carmen Espina
- 21 Jul 2022
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If you are a real estate professional, investor, or even casual onlooker, at some point in the last seven or eight years, you must have asked yourself, “When is this run going to be over?”
Since the Great Recession of 2008-2010, real estate has been on fire just about everywhere in the country. By “on fire” I am referring to continued and record-breaking appreciation. Except for the mini-blip that occurred during the global pandemic, we’ve been on a run of epic proportions. Just about anyone who participated in real estate during the last 10+ years has done so with some level of success, with many people experiencing tons of success.
Interest Rate Impact
As of the time of this article, real estate has not experienced much, if any, of a slowdown. But many factors are now pointing to a cooling off period, notably due to rising interest rates. In the first and second quarters of 2022, interest rates have surged, and they are scheduled to continue climbing while our government battles to get inflation under control.
These interest rates directly affect a consumer’s ability to buy a home, specifically how much home they can buy. Most consumers looking to buy are primarily interested in their recurring monthly payment, and higher interest rates mean higher monthly payments.
According to Redfin, in March/April 2022, the median home price across the country was approximately $408,000. The typical 30-year mortgage rate during that time was 5.27% (Federal Reserve Bank of St. Louis). If you apply the average down payment of 6% (ATTOM Data Solutions) to this $408,000 home, your monthly payment would be $2,122 per month. In contrast, four months earlier in Dec. 2021, the typical 30-year mortgage was 3.11%. If you apply that rate to the same house, with the same down payment, the monthly payment would be $1,640 per month—a $482 per month (or 29%) difference.
This is what we need to prepare for. Less affordability means fewer buyers; fewer buyers are an indication the market is shrinking. To some, this development may be reason for concern. To others, it may bring opportunity. But many of us will be left wondering, “What’s the move?”
Real estate as a whole, particularly new inventory, is stable. In fact, it is estimated that our country is running an inventory deficit equal to about 3.8 million homes (Freddie Mac, April 2021). This means there is enough buyer demand today (uncorrelated to rates) to absorb 3.8 million new homes. This is part of the silver lining of a potential and likely slow down: People will still need houses and when people need houses, real estate investors thrive.
But if affordability is an issue, how do you continue to operate a real estate investing strategy if the last 10 or so years have been (for all intents and purposes) easy? The answer may lie in the asset types in which we are investing.
3 Tips
As a private lender, we see all kinds of deals and have plenty of data to help inform our decisions and our strategy. Prior market slowdowns have also helped provide clarity in what the markets do during times of uncertainty. As we navigate this brave new real estate market, keep in mind the three strategies below to focus your time, money, and energy
1. Focus on affordability.
This does not mean that million‑dollar (plus) homes will be less attractive to buyers or less profitable for investors. It simply means the buyer pool has become smaller.
By focusing on affordability (whatever that means to you), you can attract buyers who can no longer qualify (i.e., afford) the more expensive homes they were looking at during the last several months. By all measures, the buyer pool has and will shift down a notch in all property segments (from starter to luxury homes). Focusing on homes at or around your respective market’s “median home price” will certainly allow you the luxury of a larger buyer pool and may result in quicker sales—a key in value-add investing when holding cost can take up so much of your bottomline profits.
2. If they are not buying, they are renting.
If fewer people are buying but still need a place to live, what do they naturally do? They rent. By focusing on a rental strategy, you may find that you can withstand the storm of a downturn (whether mild, moderate, or severe) as income producing properties “pay for themselves.”
There are economics at play here too (higher interest rates also mean higher payments for landlords), but a property with income is always better during a time of uncertainty than a property without income. As an added benefit, should property values see any sort of a decrease, you may also find yourself “buying right” during a cool-down period.
3. The deal is still king.
When in doubt, investors can find some comfort in knowing that one of the effects of the bull market of the last 10+ years is that capital is now abundant—more so than at any time in the history of the country. Deals, however, are scarce, making them the prize. Remember that 3.8 million housing deficit? Read More...
