We’ve seen inflation and interest rates tick up over the past few months, which creates a lot of uncertainty and concern. Many of our clients are coming to us with questions about what it all means and what they should do. Today, we’re going to talk about what we’re seeing, our expectations, and where there are opportunities in the marketplace. The market is changing, but change creates opportunities.
- Listen to the podcast “#85: 4 Real Estate Investing Strategies to Combat Rising Inflation” on the Colorado Springs Real Estate Investing Podcast
- Watch the YouTube video (at the bottom.)
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Yes, Inflation Is Climbing
Everyone is talking about inflation lately because it’s definitely going up. Traditionally, real estate is the best hedge against inflation. And since inflation is bigger than all of us, we just have to jump on the train and let it take you where it’s going.
The best way I can wrap my mind around why real estate is the best place to park my money is this: I’m using leverage to purchase a property, borrowing 75-80% of the asset’s value, meaning I’m only putting down 20-25%. If inflation is causing asset values to rise, I get to keep 100% of the equity differential. If a property value goes up $10K, I get to keep all of that equity, even if I only put down 25%. I don’t have to share $7,500 with the lender.
Interest Rates Are Going Up, But So Are Rents
We all know interest rates have been steadily climbing since the end of last year. At the same time, we’re also seeing significant rent growth all over Colorado. This helps with the cashflow spread that is constricted from higher interest rates.
When we fill out our spreadsheets, our usual assumptions are 3% or 4% appreciation and rent increase, but these are no longer the standards. I encourage everyone to play around with the numbers on their spreadsheets and see how slight adjustments change things. How does higher rent appreciation affect your returns?
How Do I Adapt to the Market?
None of us can change the market, so we need to change our strategies. The same approach we took when interest rates were low isn’t going to work in today’s market.
Strategy 1: Should I Look at ARMs?
We haven’t talked about Adjustable-Rate Mortgages (ARMs) because we’ve been spoiled with 30-year fixed rate loans that had historically low interest rates. Now that interest rates are increasing, it’s worth looking into ARMs if you have the risk tolerance for them.
As of the time of this recording, generally speaking, ARM loans can bump your interest rate down pretty significantly. Some people using an ARM could see a .75-1% drop, from ~5.5% to 4.5%. These rates are typically locked for 5-7 years, though the exact terms vary. This can be a good move for an investor who doesn’t plan on holding onto a property for too long, especially if the rest of your debt is locked in at lower rates for 30 years and you have adequate cash reserves.
If you’re looking into an ARM, make sure you understand all of the terms of your loan.
Strategy 2: Try a Different Rental Strategy
Cash flow is tough to come by in this market, and if that’s a priority for you, moving away from a traditional long-term rental can help. Room by room or medium term rentals are great ways to boost cashflow, though they are more time intensive.
With these types of rental strategies, you are running a business or paying a property manager to run it for you. However, we’ve seen clients cash flow while paying PMs to run these kinds of rentals, so they are a good option if you have the appetite for them.
Strategy 3: Look at a New Market
If your preference is to operate a long term rental but you still want to cash flow, Colorado Springs may not be the right place for you to invest. Looking south to Pueblo, it’s possible to buy a single-family home for around $200K and cashflow $150 a month. That market is rapidly changing, but still provides an option for those who want a lower price to entry and the possibility to cashflow.
Strategy 4: Automatic Equity in New Builds
Some of my clients are looking into new builds to get equity. The initial purchase price of new builds tends to be higher than existing inventory and they don’t often cash flow, but if you can get in during the first phase of development, you’ll have automatic equity as the rest of the neighborhood is built.
One client of mine bought a townhouse in Colorado Springs during phase one of construction for $330K. Now that the neighborhood is in phase three, the same home is going for $350K. That client has $20K in equity just because they bought at the right time.
That doesn’t mean that every new build will appreciate $20K in a few months. But since we don’t expect prices and rents to collapse any time soon, the worst-case scenario is prices stay flat. That’s still a good place to put your money as inflation increases. Plus, builder’s warranties can reduce capital expenditures for the first year or so.
Stay Up to Date on the Latest Trends
As the market continues to shift, we’re going to keep updating you on the latest trends. In the meantime, reach out with questions and fill out our consultation form for a one on one strategy session.