The million-dollar question:
Is now a good time to buy real estate?
Feels like every other day I get asked this question.
30-yr fixed mortgage rates are hovering at 7% — the highest they’ve been in 20 years.
Yet the Case-Shiller U.S. National Home Price Index is off just 1.6% from its June 2022 peak.
If you scroll through social media there is a ton of noise.
Some folks believe housing prices are set to rise again later this year.
Others think more pain is on the horizon.
Everyone acts like they have the crystal ball when really no one knows what’s to come.
Me included.
But you’ve asked, so I’ll give you my answer:
If you can cover your monthly payments using fixed rate debt, it’s a good time to buy real estate.
Let’s break this down:
The key assumptions:
- You want a low-risk, conservative place to invest your cash
- You don’t need the money anytime soon (5+ years)
- You don’t need passive income anytime soon
- You want a low maintenance investment
- You want to reduce your tax bill
- You want to beat the S&P
The execution:
- Buy real estate using fixed rate debt
- Make sure rental income will cover all of your monthly expenses (including repairs and maintenance!)
- Run a cost seg and take advantage of 80% Bonus Depreciation in 2023
- Refinance in the future when interest rates inevitably fall (pull out cash or lower your monthly payment)
The illustration:
Say you buy an single-family investment property today as follows:
- Purchase Price: $500,000
- Down Payment: $125,000
- 30-yr Fixed Interest Rate: 7%
Your mortgage payment would be roughly $3,000/month.
If at any point in the future interest rates fall, you will have an amazing opportunity to refinance.
You will be able to pull out a large chunk of your initial equity and keep the same monthly payment.
The table below shows you how much equity you can pull out under various interest rates.
It assumes the same monthly payment of $3,000 in every scenario (hence the rising house prices).
Assumes 5 year hold
Here’s how to interpret the blue row:
If in 5 years the 30-yr fixed interest rate is 5%, and the value of your home rises by 4% on average per year, you could pull out $112,007 tax-free and still maintain the same monthly payment of $3,000.
$112K is 90% of your initial investment.
Common questions:
“What if house prices stay the same?”
You’d still refinance and your monthly payment will drop considerably, generating passive income for you.
“What if house prices fall further?”
That’s quite unlikely, but if they did you would continue to hold the asset. The rent growth would provide some extra passive income and you’d wait out the bear market.
“Does this apply to commercial real estate?”
Yes. I’m still actively looking for ways to invest as an LP in real estate syndications. As long as they are using fixed rate debt and have ample room to drive rent growth.
“Does this apply to short-term rentals?”
Yes and no. Yes, the real estate component of an STR may be a good investment. But short-term rentals are high maintenance. They require much more of your time. They should be viewed as a business.
“Wait, what is a cost segregation report and bonus depreciation?”
I’ve written a bunch on these topics before:
The Single Best Tax Strategy for High Income Earners
Bonus Depreciation is phasing out over the next 5 years. Take advantage while it’s still 80% in 2023.
The key point:
It’s easy to get scared off by high interest rates.
And normally I’m not a fan of investing in real estate without cash flowing day one.
But it has become increasingly difficult to do that.
Especially while housing prices remain elevated.
So what’s the new game?
Find a quality asset in a great location.
Make sure the rental income covers your monthly costs.
Take advantage of bonus depreciation while you can.
Then wait….
Once interest rates pullback, refinance.
Take out most of the cash you put in tax-free.
(Then do it again, but maybe in a value-add multifamily deal).
That’s it for today.
My inbox is always open!
Happy Saturday fam,
Danny