What Happens If Interest Rates Stay High?

Dave:

At the beginning of the year, there was a lot of optimism that we would see mortgage rates decline over the course of the year. So far that hasn’t happened. So the question we’re going to dive into today is what happens if interest rates stay high? What does this mean for housing inventory first time home buyers? Investors Today we’re going to be digging into it all. What’s up everyone? I’m your host Dave Meyer, and today I have Kathy, Henry and James with me to discuss where we think the market will go if interest rates stay elevated for longer. Now I know we were all feeling optimistic and it hasn’t really happened the way most people were expecting. Henry, have you lost hope? Are you still confident that you can navigate this situation?

Henry:

No, I feel like we can definitely navigate the current climate. I am optimistic at some point rates will come down, but I’m more optimistic in my ability to find opportunities in any market and there have definitely been great opportunities to buy great deals. Right now,

Dave:

Speaking of any climate, Kathy, can you just fill in our audience a little bit about what the climate actually is and where mortgage rates are right now?

Kathy:

Well, it’s not a climate that a lot of us were expecting or at this time the job market has just been so strong. It has shocked so many economists and wage growth has been strong. It’s slowing down a little bit now, but just this last week’s jobs report was it beat expectations again, and what that generally means is the economy’s doing well and when the economy’s doing well, interest rates tend to stay high and inflation is still high. So this is unexpected. This means that a lot of fed presidents have been saying we’re not going to cut rates anytime soon. Maybe not even this year. And a few of them have even said, Hey, we might be raising rates. So there’s a lot of uncertainty. However, I do have an opinion on where that might go in the next few months.

Dave:

I like that. Okay, well we’re going to ask you that in a minute, but first James, I need to ask you, are you just sick of this whole conversation or are you ready to dive in and talk about the fed a little bit more?

James:

I’m sick of the hype around the conversation. Kind of similar to Henry rates are what they are. Go find the deal that makes sense with the rates and I think sometimes when you overthink a deal and this is what’s happening, people are overthinking things, there’s all this fear, you stay on the sidelines and you miss out on good opportunities and that’s what’s happened the last 12 months. People have missed some really good deals just narrowing in on this rate and trying to predict it. But as we all know, we predict wrong a lot so.

Dave:

Well that is definitely true

Kathy:

And we’re not alone. Some of the biggest teams with Yeah, they’re wrong too because it’s surprised everybody.

Dave:

Yeah, it has been very surprising. But I have this run of show that we use to ask questions. It’s sort of our outline for the show and the number one question is making you guys predict where rates are going to go. So even though you just said that you’re wrong, I’m going to ask you, Kathy, do you think that, let me just ask a more general question rather than something specific, but the idea at the beginning of the year was that rates were going to trend down. A lot of people were saying they were going to get into the high fives. I’m happy to say I never actually expected that, but the idea that they would trend down made a lot of sense to me. Do you still think that general concept holds true even though the first quarter of the year hasn’t seen that actually start to happen?

Kathy:

Yeah, I can say with all certainty rates are going to come down someday. We just dunno where that day

Dave:

Is. Our predictions are just going to get more and more general. They just take all specificity out of them and we might be right.

Kathy:

Well, what the Fed is really looking at is jobs, and one thing that I follow housing wire a lot and Logan, Moe basically pointed out that if there had been no covid, the number of jobs that they would have today would be between 157 and 159 million. So right now we’re 158 million. So a lot of this massive job growth is just really jobs coming back from a crazy pandemic, but it looks, it’s skewed. Everything is different because of a time that we’ve never experienced where suddenly no one was working and then jobs came back. So if we’re at 158 million today, and we would be right around here if there was no pandemic, I am predicting along with Logan that it’s going to start to slow down and we’re already seeing wage growth slow down so when the Fed has some confirmation that we’re not going to be just on this train ride of the economic train that’s been moving so fast and so speedy and creating inflation, once they see that slowing down, then we’ll get back on that rate cutting plan and mortgages will likely come down too. So that’s my prediction is that they will come down and if it’s not this year, it’ll be next year and no one can predict exactly when that will be. So your plan just needs to have that in mind that yeah, they’re probably going to come down, we don’t know when. So what you buy needs to make sense today and it’s going to make even more sense later when you can refine to something lower.

Dave:

Well that’s a great point and thank you for providing that context, Kathy. I actually saw something recently that said that the Fed is going to be paying less attention to jobs than they had been saying that because even though hiring has been really strong and inflation is still higher than they want it to be, inflation hasn’t reac accelerated and it hasn’t started growing with better jobs reports. It’s sort of just staying at this low threes. They want to get into the twos, but they are seemingly willing to tolerate a stronger than they had anticipated labor market. James, what about you? Do you still expect rates to come down or are you basing your business decisions right now on the fact that rates may stay flat or perhaps even go up?

James:

I still think rates are going to start ticking down towards the end of the year. I am seeing the housing market get really tight right now and that is one thing that I’m also looking at. Obviously there’s tons of factors that go into the Fed’s decision, what is going to happen to interest rates and part of it is housing and the housing costs, which does drive up inflation as well. What I’m seeing in the market right now is people are bidding stuff up, affordability on their pricing is getting really tight and they’re going to need to do something to fix that besides try to figure out where new inventory come from. But as investors, if I think that rates are going to be lower in six to nine months, that’s just upside to me in the deal. I don’t look at any deal today based on we don’t speculate.

If we like the deal on today’s numbers, we will buy and if the rates do go down in nine months, that’s just upside. And what I can feel a little bit more confident is if rates even do tick up a little bit, what we’re seeing is rates are high, inventory is low, and even to my own disbelief, I thought pricing was going to have to come down and is going up. And so I can feel fairly confident in my buys today because I’m seeing properties get bit up 10% over list at rates where they’re at now and we’re pumping past when the rates were at three and a half percent and so maybe it won’t matter as much, but I think the concern about their interest rates that’s going to crash the economy or the housing market really isn’t coming to fruition. If it does go down, it’s going to be from something that we’re not even talking about on the show.

Dave:

That’s a really good point. The things that we know are really pointing in a fairly clear direction about the housing market, it would take what people would call a black swan event to probably alter the course in a dramatic way if you’ve never heard that term back swan event is basically an event that happens sort of outside the normal variables that impact any industry. So this would be something like nine 11 or the Russian invasion of Ukraine or the COVID-19 pandemic where all the forecasting, all the data analysis you want to do, you can’t predict those types of things. And I think just going with traditional data analysis here, I agree with you James, it doesn’t look like rates are going to bring any sort of significant nationwide crash into housing prices. Henry, let’s just, I put James and Kathy on the hook, so I got to ask you as well, do you think rates are going to come down through the end of this year?

Henry:

In all honesty, Dave, I don’t care.

Dave:

Your questions bore me, ask me something else,

Henry:

But here’s why. It’s exactly what James said. So what happens when you have the environment we have now where rates are what people consider higher is yes, I’m going to still buy deals that make me money now and James is right, we’re only underwriting deals maybe 90 days back max like it’s what’s happening today maybe 60 days ago. That’s how we’re evaluating what’s going on and how we should value our properties. So what that really does from an investment standpoint is it might slow down our growth. When I was buying properties at a lower interest rate, they were cash flowing more, they were making me more money so I could afford to do more. Since interest rates are higher, cost of money is higher, those things, the cash flow isn’t as high, which means I can’t buy as many properties so it may slow me down a little bit. You still have to be able to sustain the things that you were buying, but we’re not stopping buying because of those rates. And it’s exactly right. I am going to get icing on the cake when rates come down because weights will come down. It may be five years from now, but that’ll come down eventually

Dave:

All. Well, first of all, I just want to say what James and reiterate sort of what James and Henry said is I strongly, strongly believe that you need to be underrated based on today’s rates because as we’ve seen over the last few years, no one really knows what’s going to happen with rates. And as I’ve said many times of the show, I love putting myself in a situation where I benefit from being wrong. It’s the best of both worlds. If you find a deal where rates stay the same and it works and then you’re wrong about rent growth, you’re wrong about rates going down and you make even more money, that’s a great situation. I love that kind of situation and you can definitely underwrite that way to make sure that your deals work out in such a way. I will just jump in and say and just provide my own thoughts.

I will be a little bit more specific. I do think that rates are going to come down a little bit from where they are. They’re right now as of this recording, which is, what are we at here? We’re on April 8th. We are recording this. They are at around 7% today. I do think by the end of the year we’ll be somewhere between let’s say 6.25 and 6.75 so that they’re going to come down a little bit but not into the fives. And I’ve sort of been believing this for a while because this is a complicated topic and rates just always come down slower than they go up. And I think that that’s number one. Number two, even if the Fed does lower rates, bond yields have climbed a lot over the last couple of weeks and they could stay high even if the fed cuts rates.

So there’s all sorts of things that are suggesting that we are not going to see as much movement in rates as people predicted. And so because no one knows, maybe to sort of flesh out our conversation here, let’s use this as a straw man. Let’s just use this assumption and talk about what might happen throughout this year. If I’m right, I’ll probably be wrong, but I think it’s a reasonable guess that we’re going to be somewhere around six and a half at the end of this year. Now that you’ve heard our predictions about the market or maybe us skirting around making predictions, we are going to talk about the state of the housing market if rates do stay high, stick around. Welcome back to the show. Kathy, what do you see happening with housing inventory because that’s sort of been the big story here this year other than rates is like we’re seeing a little bit of an increase in inventory but not that much. And if rates don’t come down, we may not see the lock in effect breaks. So do you think we’ll see that trend reverse or more of the same? What do you think will happen?

Kathy:

Well over time people do start to get used to the status quo. So maybe people will just start to realize this is where we are, we’re in the sixes and sevens. It’s not that unusual. You got to find property that works for that. And because wages have gone up more and more people will be able to afford even at those higher rates, the more affordable housing will be less affected by these higher rates. Yet you’ve got the high-end market where people just have money and they don’t care about rates. So the super high end, maybe it’s just not as affected. And affordable housing, not so much because when you really look at the difference in payment, it’s not massive. I’m talking about a hundred or $200,000 house. So it seems like the middle class might be more affected the what is the median home price now the 400, so you’re getting into five and sixes in terms of price, you can feel that.

But if I were to guess, I would say we’re going to continue to have this inventory problem for a while. And if you just look at the number of people in the US there’s 330 million people in the US I haven’t checked recently, but there’s a lot of Americans and now I think over 3 million more immigrants just in the last few years. And typically a good housing year of sales is about 4 million houses, three to 5 million houses trading hands, but usually about 4 million. So you don’t need to have that many home sales compared to the amount of household formations to keep housing stabilized. So I think it’s going to continue to be the supply versus demand story. There’s more demand than supply and there’s enough people who can’t afford even at these high rates that housing will stay strong. And we’re seeing that, right guys, you’re still seeing buyers all over the place. Absolutely.

Dave:

Yeah. So James, Kathy mentioned people with money that I would describe Seattle as a wealthy city. There’s a lot of high earners in that area, one of the highest median incomes in the country. Tell us what’s happening in your market. We do see little upticks in new listings, but are they just getting gobbled up? Are they just coming off the market quickly?

James:

They’re gone. I’ve seen the data about uptake in new listings, but the absorption rate is so fast right now. There’s so much pen up demand in our market where you can go out two, three miles and not find one house for sale in areas, especially if it’s a more affordable price point. And then even if you want to talk about even more expensive market, Newport Beach where I am, that market moves and it moves with cash and these homes are appreciating at 5%, 10% and it has became one of the most expensive markets in the whole us. And I saw something come out that said the average price per square foot is now at $2,000 a foot in Newport Beach. Oh my gosh. So I’m really happy that I just bought a house for 1100 a foot. Whoa. Wow. And that’s the biggest thing right now is you have to buy on the now and figure out where the demand is.

And if there is no inventory and there’s high absorption rates, then people are affording it. And it is, to my own surprise, 12 months ago I thought there was going to definitely be a pullback, which there was, but it rebounded back. That pullback was based on fear. It wasn’t based on actual affordability and that fear caused this blip in the market, but we are seeing it race back and it’s really hard to find deal flow. And I think what people have to do is they have to look at the new investment strategy. Everyone goes back to these old rules. The 1% rule, you can do it this way, the house hack, you can do a burr. Those are strategies you can implement, but the math is going to change. How we were buying back in 2008 was a lot different than we were buying in 2015, and how we looked at deals was a lot differently. And now how we’re looking at ’em today has to be different. And it’s about how you cut the deals up and if you get stuck in that old way of underwriting properties, you’re going to make old returns. They’re not going to be that great. And so you have to shift with that market and rates are probably here to stay. Inventory is locked up. I didn’t think it was going to be this locked up at all. I thought there was going to be more inventory coming to market and it is compressed.

Dave:

Henry, are you seeing changes in the type of demand that you’re seeing? Is it the same kind of transaction? Is it mostly at the higher end of the market?

Henry:

Yeah, no, we’re seeing demand really across the board. So the types of properties that go quickly here are your typical first time home buyer property. So your three bed, two bath, 1200 to 2200 square foot home, if it’s done right, it’s gone. We also have a influx of people that are looking to buy that next tier home, the three to five bedroom, three to four bathroom, 2000 to 3000 plus square foot house because of the corporations that are here bringing in the high earners. And so they’re either building those houses or they’re snapping the good ones up off the market. The luxury flips are taking longer the things that are above those price points. But if you’ve got something in a desirable neighborhood nearby one of these employers that’s in that mid tier and it’s done right, gone. If it’s under $250,000, it’s getting looked at and it’s probably getting snapped up.

Dave:

That’s not what I was expecting you to say to be honest. I thought you were going to say luxury things are doing well, sort of what James was alluding to, but that just shows how regional differences do make sense. And it sounds like what’s fueling your market is people who are either coming in or landing some good jobs given the really strong job growth and high wages that are coming to your market. Correct. Kathy, what do you think this all means for the younger generation? Maybe the people who don’t already have enough money to spend $2,000 per square foot, which is all 12 of James’s neighbors and no one else in the whole country or the people who are getting jobs like in Henry’s market. What does this mean for the average young person who just wants to buy their first home?

Kathy:

Oh, that’s been an age old question. It’s never been easy really to buy your first home. Honestly. Again, I go back through the decades, that’s always been an issue. The one time that we had rates so low and it was so easy for anyone to get in the housing market, that’s sort of blew up as we know. So you would just have to educate yourself. That’s the best thing I could say. People are doing it. People are doing it every day. Just an anecdotal example, I was speaking to a babysitter, she’s 24 years old, she’s going to buy her first house, she’s doing it with other people and she makes $24 an hour. So there’s ways and you have to get creative and understand the power of it that let go of all the other things you’re spending your money on the things that you can let go of and put it into assets that are going to inflate over time and are going to make you wealthy over time.

It does take sacrifice. Many of us sacrificed to get to where we are. We shared our house with three or four other families. The first house we bought, we carved it up different rooms and had friends move in and that’s how we made it work. So not everyone is going to get out of college and get a hundred thousand dollars salary and those who are probably in expensive markets where they can’t afford in that market, even with a hundred thousand dollars salary. So again, you just have to get creative and there’s ways, we all know there’s so many different ways to do it. You just have to learn how. I

Dave:

Think an important thing you said is that it’s always been difficult and that is true, especially I hear this term, people always say, oh, we’re becoming a renter nation. The data does not support that idea. Actually you can Google it. I encourage you to, if you just look at the homeowner percentage in the United States back into the sixties, it’s always been between 63, 60 9%. Right now we’re at 66%, so right in the middle there. But obviously that can change. And with the affordability issue here, Henry, I’m curious, do you think there’s going to be harder for people than it has historically to afford a starter home? And does that mean that there’s going to be more demand for rentals or what are some of the implications for this challenged affordability?

Henry:

It’s hard not to think it’s going to be more difficult because we just keep seeing prices climb. We keep seeing rents climb and yes, there are more jobs out there and people are getting more high paying jobs and that’s going to help some of the affordability. But I think there is, there’s going to be a subset of people who continue to be priced out of being able to buy a home. And I think not only is that going to play into that, but you’ve also got the additional cost potentially for some people with having to pay for a realtor out of their own pocket to come and buy some of those homes. And so I think it is going to be challenging and I think you’re going to start to see or hopefully start to see some ways for people to be able to jump on the affordability train.

I think education has to be key here. There’s never been, or there’s not really a lot of formalized education for people in terms of helping them understand where can they go and look for first time home buyer programs that can help them offset some of these costs. In almost every state there’s typically a program, but unless you know someone who knows this information, a lot of people have access to it. So education is key and helping people put together plans and budgets for being able to buy a home. I think a lot of people don’t truly understand how much they need to have set aside and how much they need to be making to to afford it. A lot of people don’t really even start thinking about that until they’re ready to start making offers. And so I just think education and access to resources and programs to help them understand will go a little bit of the way, but there are going to be several people just priced out.

Dave:

Yeah, I unfortunately agree. I wish it was easier for people to afford and there wasn’t this affordability problem, but it does seem like it’s here for at least the foreseeable future and hopefully something will come along to make it a bit easier. We have more on this conversation right after this quick break. Welcome back to On the Market. James, I want to ask you sort of the flip side of this question, which is do you anticipate fewer investors being in the market? Because as you said, you sort of have to change tack, you need to look for different strategies, you need to underwrite deals differently. Do you think the average investor is willing to do that or people are going to bail and put their money somewhere else?

James:

We definitely saw investors bail out a lot in 2023, but I feel like the gold brushes came back because again, the fear has loosened up. We broke our record last month for lending hard money and we were down on volume for a while. We lent nearly two x what we had lent in the last five months per month and there’s this mass surge going on. I think investors will continue to buy. I think they’re going to have to buy differently, and if they want to put in the time and work, then the activity will go on. But have to, again, you got to cut up your deal differently. You got to look at it different. How is it? It’s more about how you look at it right now. If I’m looking at rental property, I’m not looking at my cash flow. I’m looking at my return on equity, what can I create? There’s my true return and I still can’t find anything that’s going to give me a hundred percent return on my money in 12 months with equity. Maybe Bitcoin if you just get lucky, I don’t know.

Dave:

Yeah, why is a hundred percent return the benchmark if you find a hundred percent return, sign me up. But I think the normal benchmark would be 8%, which is the stock market.

James:

Well, and that’s the thing, you can still make those returns in today’s market. If you can flip a house, you can create 20, 25% equity. That’s what you need to be profitable on a flip. And if you’re putting in 50,000 and you create 50,000 in equity, that’s a hundred percent return in value right there. And I think if people switch their mindsets, they’re going to continue to buy. And at the end of the day, investing in real estate, if you think it’s going into high inflation, like Kathy said, it will go up. And so I think investor activity, it goes in surges. The fear has gone away. We’re seeing a surge again, if there’s anything else that happens to the economy which could happen, there’s a lot of weird things ruined in the background, then you’ll see an exodus again. And so that’s what I have really learned is by when people are freaked out because that is when you get the best deals.

Henry:

Yeah, I mean 100%. I agree with you James. I think what this economy is doing is for investors anyway, is it is creating stronger investors because of the economic climate and it’s forcing investors who are staying in the game, who got in when things were so much easier, it’s forcing them to learn how to pivot and it’s forcing them to be fundamentally sound investors. Nowhere have we ever said that this is a business where you’re going to make a whole bunch of money in the first 60 days of you owning a property or the first year of you owning a property, being a landlord anyway. So being a landlord has always been a long-term game. We’ve just been really spoiled over the past three to five years because we’ve had great rates. We’ve had prices going up, we’ve had rents going up and you’ve been able to make great returns.

But now in a more, I don’t want to call it normal market, but a probably more realistic market, the fundamentals are more important. When you’re underwriting a property, you actually have to scroll down to the bottom of the calculator and look at the 30 year cashflow prediction, not just the year one, am I making the money today? But what’s this going to look like in three years, five years, seven years, 10 years? Right? Because it is a long-term play. And can you sustain owning that property until you get the payoff that you want? And if you can’t, then that’s probably not a deal you need to do. These are the things that we have to do now when we’re underwriting our deals that maybe a lot of people didn’t do over the past five years. They’re like, oh, it’s not paying me $7,000 a month cashflow on day one. Get it out of here. I’ll go get another one. Right? It’s just not that game anymore.

Kathy:

I want to say that in some ways I think it’s easier than it’s been because there’s always forces at play. Whatever is happening in the market. And during Covid, there was so much competition because rates were so low. It was, remember you guys, it was like multiple offers on everything. And that’s hard. That’s different skills than today where today now there’s a lot less competition and in some cases none. And you also have certain people in distress under the current situation. So in my opinion, it’s easier today than it was a few years ago just because interest rates were lower than doesn’t mean it was necessarily easier to find the deal.

Dave:

I think we all just need this sort of industry-wide resetting of expectations. The reason I asked you, James, about the a hundred percent return is I was talking to someone over the last week and they were talking about deal cashflow is harder to find. This is harder. I was like, yeah, and it’s still a way better investment than anything else that you can do with your money. And I went to the point of just doing all of this math and analysis and I decided to just take an on-market deal in a market that I invested in the Midwest and just find a random on-market duplex. I just pulled it down, I ran the analysis for it and what it showed, this is buying full, asking price on market deal. And it returned. If you add up the amortization, the value add, the cashflow, which was only like three or 4% and the tax benefits, it still yielded a 12% annualized return.

The stock market offers an 8% annualized return. And if you know anything about compounding, the difference between 8% and 12% is actually enormous. If you invested, sorry, I’m going to go on a rant here. I did this all this week. This is what I spent my weekend doing is if you invested a hundred thousand dollars at 8% stock market after 30 years, you’d have a million dollars pretty good, right? If you invested that a hundred thousand dollars into my on market random deal instead of a million, you’d have $3 million. You would have triple the amount that the stock market return. And that’s my boring, regular on market deal. So I think people just need to start forget. Yeah. Was it easier to find cashflow 10 years ago? Yes. Does that matter? Absolutely not because it’s about where you need to put your resources right now and it’s still the best asset class to put resources in. So there’s my rant. Sorry, I had to say that

Henry:

Soapbox, Dave is my favorite Dave

Dave:

Ever. I understand why people are frustrated. We all wish it was if it was super easy, but it’s still a really good way to build wealth, and I just think we all need to remember that and sort of normalize these types of returns. Still really good. Amen.

Kathy:

Yeah. Let’s just remind everybody that where else can you have somebody else paying down your debt for you? The government subsidizes this investment for you, gives you tax breaks, and if you just let someone else pay off your debt in 30 years, you own the property free and clear. Now, I know 30 years sounds like a long time from now. You can do it faster by taking a lot of the cashflow and paying down the loan faster, but there’s nothing that compares. And then if you decide I want access to this money, you can just refinance that property and take cash out tax-free people. So again, yeah, nothing compares.

Dave:

All right. Well, it sounds like at least the four of us are hoping with the idea that interest rates might stay higher and at least admitting to the fact that we don’t know what’s going to happen, but are still investing anyway. So thank you all for sharing your information and your feelings about what’s going on right now. And thank you all for listening. If you also like soapbox Dave or some of the answers that everyone else gave, we do always appreciate when you get on your soapbox and tell either a friend about this show that you really like this podcast or tell the whole world by writing a review for us either on Apple or Spotify. I’m Dave Meyer for BiggerPockets and on behalf of James, Kathy and Henry, we appreciate each and every one of you and we’ll see you for the next episode of On The Market. On The Market was created by me, Dave Meyer and Kailyn Bennett. The show is produced by Kaylin Bennett, with editing by Exodus Media. Copywriting is by Calico content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.