“It’s tough to make predictions, especially about the future.”
The residential real estate market is on fire. No doubt. We are seeing this across the board from single-family homes to massive apartment complexes.
I’m not an expert on single-family home values. I don’t understand them as they are not rooted in cap rates etc. However, I can comment on larger residential real estate.
Cap rates have gone down primarily because of mortgage interest rates being at historic lows. This is just math. Leverage only works if the money you borrow at is less than the cap rate. Otherwise, you are leveraging losses, not profits.
So the question I often get from investors is, “What if interest rates go up?” It’s a good question but we have to understand that no component of the economy happens in a vacuum.
Cap rates are low because interest rates are low. Interest rates are low to avoid asset deflation. The fed is controlling mortgage interest rates by buying up 10 year treasury bonds.
The 10 year treasury typically reflects inflation. If it goes up, that means we’ve got inflation on the horizon. So, even if cap rates go up following increased mortgage interest rates, we should be able to raise our rents to match that inflation and offset the negative impact on us as sellers with increasing cap rates. That’s why I consider apartment complexes a hedge against inflation.
But the reality is that the economy is pretty darn fragile right now. The likelihood of the Federal Reserve allowing interest rates to naturally rise seems unlikely as any downward trends in the economy would likely result in a knee-jerk response and economic stimulation.
Of course, I could be wrong, but my personal feeling is that we have a runway of a good 5 years or more before the party ends.
So what to do? I’ll tell you what I’m doing. I’m doing what I always do. I’m investing in value-add real estate that does not rely on market appreciation to be profitable. If the market keeps heading north, then great. If not, it’s not the end of the world. We still have equity that we force through our value-add programs.
The bottom line, in my view, is that a reasonable approach is to continue to volume average into your investments. Not investing in an inflationary environment guarantees the loss of your buying power so you don’t have a lot of choices.
But my friend Jorge Newbery is trying to give us a few more choices. He’s a little less enthusiastic about the market over the next few years and is hedging his bets in a different way.
On this week’s Wealth Formula Podcast, Jorge gives us his perspective on the real estate market and his formula to come out ahead in this economy either way.
In 2008, Jorge P. Newbery founded American Homeowner Preservation to buy distressed mortgages at discounts and offer struggling families sustainable solutions to stay in their homes.
However, when the homes backing the mortgages were vacant, he recognized that lenders frequently struggled as they tried to limit their losses.
In 2020, Jorge founded preREO to get these vacant properties into the hands of local investors during the foreclosure process which mitigates losses to lenders and accelerates returns for investors, a win-win.