When interest rates shoot up, the real estate market inevitably feels the tremor.
For many, affording a home becomes a towering challenge. Let's break it down. Today, financing an average starter home priced at $900,000 (with 5% down) will set you back $5,725 monthly. That's almost twice the rental cost for the same home.
To qualify, without any other debt, you'd need an after-tax income surpassing $220,000. And here’s the kicker—you'd have to qualify at rates 2% higher than the standard ones, which means over 8%.
This same starter home is often what new buyers and investors are both eyeing. Historically, these homes were great for positive cash flow. Imagine a $900,000 home, leveraged at 2.5% interest. It would bring in a profit with just $3,000 in rent monthly. But this profitable picture was largely painted by affordable loans.
However, with economic instability, banks tighten their grip. Rates for non-owner occupied property buyers can surge by 1% to 1.5%. Banks also set strict guidelines regarding the debt coverage ratio, which essentially measures if the rental income can comfortably cover the property's expenses (and then some).
With current rates, most investors would need to make a hefty down payment—often more than half of the property’s value—to even consider a positive cash flow.
Borrowing against your primary home for another property's down payment? Once a viable strategy, it now seems a distant memory. Simply put, the costs of borrowing heavily outweigh the returns from rentals. This shift has left many potential real estate investors on the sidelines.
While there will always be buyers for lower-end single-family homes, albeit fewer, the investor-specific properties, like fourplexes and apartment buildings, face uncertainty. Some landlords, especially those using variable-rate mortgages, find their investments draining their pockets.
Their solution? Selling the property. But here's the snag, prospective buyers face the same soaring interest rates.
To understand the math, let’s dive into ‘cap rates,' a term investors throw around to measure an asset’s return. It's calculated by dividing the asset's value by its net operating income (NOI), giving a percentage as the result. But with higher property prices, the returns diminish.
In a world where investors won't borrow at 6.5% for a 4% yielding asset, the numbers simply don’t add up.
Unlike a young family fuelled by dreams of homeownership, investors prioritize the bottom line. If the income from a property remains stagnant (or even declines), the only logical way to boost returns is to slash prices until the yield is enticing enough.
Enter the cash buyer.
These investors have two unbeatable advantages—no competition and no interest rates to fret over. The ability to close a deal quickly, say in seven days, often leads to significant discounts.
This is the game plan my investment fund, CashOffer LP, banks on. The next step? Wait out the economic storm. As history suggests, the Bank of Canada eventually loosens the reins on interest rates. By then, property values rise, and the smart cash buyer can refinance, earning a significant profit, all while enjoying a steady cash flow.
For those ready with cash to dive in, the next 12 to 18 months promise a golden window of opportunity.
I’m gearing up for it, and if you'd like a deeper dive into my strategy for this high-interest landscape, watch this video on Youtube. Or feel free to reach out, I'm open to sharing my playbook.
If you are interested in learning more about the current market dynamics and what it means for everyday buyers and sellers, you can always catch our latest Vantage Report
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.