Interest Rates Are Creeping Up. How Will This Affect the Single-Family Home Rental Market?
By: Tom Brady
Most forecasters are expecting mortgage rates to rise in 2021, which could give pause to some buyers when they are crunching the numbers on home affordability. But the biggest impact on housing prices — and why they have been on a tear in recent months — is that there is a shortage of homes on the market, according to Don Ganguly, senior vice president of Mynd Investor Services.
“A lack of inventory is really jacking up home prices,” Ganguly said. With investors forced to pay higher prices because of the increased demand and the looming increase in rates, they are “not getting as much juice month to month with cash flow.”
Rates Still Historically Low
Even if mortgage rates rise to the mid-three percent range for the rest of 2021, as most forecasters predict, rates are still at historically low levels and “the sky is not falling,” Ganguly said.
The rates for an investment property are generally about a half percent higher than it is for a primary home, so if rates start drifting up above four percent, owners who are generating about five percent cash flow will start to see their margins squeezed.
“If your cap rate and interest rate get pretty close, then the calculation changes” for investors, Ganguly said. “You’re going to be pressed to get cash flow.”
Key Reports Out Soon
There are a number of key economic reports that will be released in April that will help influence that, and offer some hints as to just how rates might go.
- Unemployment rate — It fell to 6.0 percent in March, as the U.S. added 916,000 jobs, signaling a strong economic recovery that is likely to exert upward pressure on rates.
- Federal Open Market Committee minutes (April 7) — This report from the Federal Reserve’s March meeting may reveal if the Fed is taking inflation more seriously.
- Inflation rate (April 13) — Economists are expecting higher inflation numbers for March and the coming months.
- Retail sales (April 15) — Since 70% of the economy is driven by consumer spending, higher sales mirror a hotter economy and more inflation.
- FOMC meeting and rate announcement (April 28) — The fed funds rate isn’t expected to change, but the Fed’s announcement will be scrutinized for signs of inflation worries.
- Gross Domestic Product growth (April 29) — This quarterly report will reveal how the economy’s COVID recovery is going. The faster it expands, the higher mortgage rates will go.
Inventory Remains Low
Even with the pandemic spiking unemployment and many Americans struggling, the housing market is out of whack as many more buyers are chasing a shrinking number of available homes. Housing inventory is near a record low and homes that hit the market are selling quickly — just 20 days on average.
There are steps buyers can take to succeed in this competitive market:
- Get pre-approved before making an offer.
- Don’t bid the entire amount right away -- that leaves you with no room to negotiate if you need to up the offer.
- Try to minimize contingencies, which can slow down a deal.
- Do not skip the home inspection -- if a property has serious problems, you’ll want to know about it before buying.
Choosing a mortgage lender is an important part of the process and can cost you in the long run if you don’t do your homework. A quarter of a percentage point off a 30-year mortgage rate for a $250,000 home can save $10,000 over the life of the loan.
But a potential buyer needs to look beyond just the mortgage rate and study the fees associated with a mortgage. Bigger upfront fees can offset the savings from a lower mortgage rate. A loan estimate from the bank, which should come days after submitting an application, will allow you to compare fees and rates.
Higher rates can be boon for those who invest in single family homes since fewer people may qualify for mortgages and will need to seek out rental housing. According to an analysis by the National Association of Home Builders, the rise in rates over the last two months has put a median-priced home nationally out of reach for more than 1.3 million households.
Still, rising rates can dampen demand and ultimately lower home prices, so investors should look to buy before rates rise too high and make the economics of renting untenable.
Increase in Renters Likely
With mortgage rates still hovering near historically low levels and stock prices appearing to be entering a volatile period, investing in real estate is an attractive way to diversify a portfolio. Some analysts predict there is likely to be an increase in the number of people looking to rent homes as people look for larger spaces to accommodate home offices.
Rental properties do not qualify for federally backed loans such as those provided by the Federal Housing Administration, the Veterans Administration or the U.S. Department of Agriculture. These purchases can be financed through conventional mortgages or jumbo loans.
Those who already own a home can access money for an investment property through a home equity loan, or a home equity line of credit. Another option to raise money for a purchase is a cash-out refinance on a primary residence, but there are fees associated with these loans that can make them expensive. Fannie Mae, for instance, charges .375 percent to 3.125 percent of the entire loan amount in risk-based surcharges for a cash-out refinance. (Note this is for the entire loan amount, not just for the cash out portion.)
Despite these hurdles, investing in rental properties remains an attractive option.
Property Management Can Help
For those who can finance a rental property and are willing to outsource property management to a company like Mynd that can help maximize income with little stress, they can expect solid returns over the long term. And a lot of folks are now looking for more space as the trend in working out of the house appears to be part of the new normal.
“Rental housing demand is going to continue. Some percentage of people are going to work out of their houses for some period of time,” Ganguly said. “A lot of those people may not want to buy so you are going to have a spillover from the apartment rental cohort who are looking for a home in the rental market.”
Another factor that favors the rental housing market is the disruption in employment patterns in the wake of the pandemic. Some jobs that were automated while employees were forced out of the workplace will never return. Instead, more people are working remotely and more are likely to continue to do so. Other sectors, including retail and service jobs in large cities, have lost ground and are unlikely to recover.
What this means is that some percentage of the workforce will be forced into new careers that will pay less in many cases, meaning the purchase of a home will be out of reach.
Still, some $3 trillion in government aid is buying time for people to navigate the crisis, even if it means they will have to delay their dreams of purchasing a home, or holding on to the house they have because they are not earning as much.
“Have these folks found meaningful employment?” Ganguly said. “The whole point is to give them time to find meaningful employment.”
Again, this bodes well for those invested in rental properties, and it’s a haven for investors who prefer the predictable income stream it generates. Aside from using the proceeds to pay down the mortgage, many rentals generate cash flow.
And owning rentals also offers tax advantages, since the properties let owners take deductions that can reduce the tax on profits. Common deductions include mortgage interest, repairs and maintenance, insurance, property taxes, travel, lawn care, losses from casualties, as well as other fees associated with the property.
The biggest problem these days is to find a property to invest in, as the overheated market has spurred bidding wars, and higher prices lead to lower returns on investment.
Still, Ganguly is optimistic about the economy moving forward.
“I don’t think we’re going to see the foreclosure mayhem we saw during the last crisis (in 2008),” he said. “I’m only seeing signals of a strong recovery and it will lift a lot of boats.”