The Federal Reserve, aka “The Fed”, is the central banking system of the United States. It was created in 1913 after a series of financial panics led to the desire for central control of the monetary system.
The Fed’s stated mission is to promote optimal employment and stable prices (control inflation).
The way the Fed approaches its mission is by influencing the supply of money or it’s “monetary policy”
There are 2 main ways the Fed influences the money supply:
- Setting the benchmark Federal Funds Rate
- Buying or selling bonds and mortgage backed securities
The Fed does not directly set home mortgage rates, however, the 2 ways that they influence the money supply noted above, undoubtedly have a major impact on them.
Beginning in March of 2022, the Fed began a crusade on inflation. Inflation had gotten out of control mostly due to the massive pandemic related stimulus programs. (aka printing money and distributing it to the public). They raised the Federal Funds Rate at a historic pace.
Ultimately the benchmark 30 year mortgage rate, after having been in the 2-3% range, skyrocketed well past 7%. Not good for us real estate investors.
However, lest we get too salty about 6%- 7% mortgage rates, let’s not forget what the alternative could have been; double digit inflation and both a loaf of bread and a gallon of gas costing $10+
Additionally, let’s acknowledge that while 6%- 7% mortgage rates seem very high in the context of where they have been over the last decade, the reality is, from 1971 through now, the average is 7.73%. So we now have “normal to below normal” rates and the past decade was the fortunate (for us real estate investors) anomaly.
One might expect that with interest rates shooting up, prices would have to come down. This has not happened. See my previous article Housing Affordability Has Not Been Worse Over The Last 40 Years which explains why.
High prices, high interest rates, and low affordability are kryptonite for real estate investors jonesing for a deal. The model and metrics that I used to build my portfolio over the years is blown up.
Even with the Fed’s September 18th, 2024 decision to cut rates by 50 basis my existing model doesn’t work like it used to and it’s no fun out there anymore. In fact, I believe the rate cuts could increase marginal demand without unlocking additional supply which means prices could shoot up again.
So what are we to do?
We have to change the game.
What Are We Doing?
Basic success in cash flow SFR investing involves achieving a favorable monthly rent (income) to cost ratio. While rents have gone up nicely, they are not high enough in most markets to justify all the costs. Not only have prices and mortgage costs increased, but so have insurance and taxes as well.
So we have to find a way to do one of 3 things:
- Increase income,
- Reduce costs
- Find some other benefit/value of owning a piece of property.
I am currently attempting to find a deal that combines all 3.
Increase Income
The typical income for a 2BR, 2Bath duplex in a B class zipcode in the type of market I like to invest in are $1,400 for 1 unit and $2,800 for both. ($33,600 annually) $33,600 of income on a duplex with a 75% Loan to value mortgage and relatively high taxes does not yield positive cash flow. We only do deals that cash flow.
So instead of our traditional Long Term rental strategy, we are pivoting (changing the game) to Short Term and Medium Term Rentals. On the same duplex, the projected income increases by almost $20,000 to $53,271. Now there are certainly additional variable cost to having STR and MTR units (in essence it’s like running a hospitality business), so that additional $20K does not just drop to the bottom line. But the overall net income increases.
Reduce Costs
Having been on the sidelines since closing our last deal in 2021, we have been able to save up some cash which reduces the degree to which high cost financing is needed.
Additionally, while not a necessity, we are seeking a deal where we can use creative financing.
There are a percentage of sellers who have experienced significant appreciation and will be faced with a hefty capital gains tax upon selling. As buyers, we can help them with this by allowing them to stay on the deed. (Not a sale for tax purposes). Instead of getting a bank loan, we negotiate favorable terms and pay them a monthly amount for allowing us to rent out the property. (Seller financing)
We acquired a single family home in TN in 2019 by assuming its existing loan. Given rates were so low prior to the recent Fed interventions, many homes have loans with interest rates below 4%. Can we find a home that fits our profile with an assumable low interest rate loan? If so, this would significantly decrease costs relative to acquiring the same home by traditional means.
The Other Benefit
We are targeting the city where one of our children is attending college as we plan to make frequent visits. Having a short term rental allows us to stay in our place and therefore reduce the amount we would have otherwise spent on hotel rooms.
I don’t begrudge the Fed for doing what they are doing, but I’ll be damned if they are going to take away all the joy of real estate investing!
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