To put today’s investment rates into perspective, allow me a short trip in the WayBack Machine. Here’s the Reader’s Digest version. The first 32 years in the business, I never saw an interest rate startin’ with a number less than a 7. I’m not talkin’ about investor rates either. No, I’m referring to owner occupied rates — conforming rates — which are less. 80% loan to value (LTV) with 20% cash down payments. Never under 7% for over 32 years. Think about that a moment, and let it sink in. Let’s see the difference interest rates make in terms of monthly payments.
The impact of interest rates on a $200,000 loan
The interest rates for investment property ranged from around 7.75% to 18% my first three decades in the business. Let’s use a few rates to see the difference in monthly payments. Let’s assume you’re workin’ with a Net Operating Income (NOI) of roughly $19,000 or so.
- 7% — $1,331/mo – $15,972/yr $3,028 annual cash flow
- 8% — $1,468/mo — $17,616/yr $1,384 annual cash flow
- 9% — $1,609/mo — $19,308/yr (Oops) Almost break even cash flow.
- 10% — $1,755/mo — $21,060/yr (Bigger oops) No can do cash flow.
What the above numbers demonstrate is where one line — rates/payments — intersect with the line representing the investor’s comfort zone. We know the work we did with our own boots on the ground is reliable, in other words, the NOI is a real world number. However, it doesn’t factor in the #1 fact of life for real estate investors:
Murphy’s still alive, and he knows where all of us live. Oh, you haven’t heard of his Law? It says, more or less — If anything can go wrong, it will — and at the worst possible time.
Ever heard of O’Toole’s Corollary? Murphy was an optimist.
With those happy thoughts in mind, I always make it a point to tell investors that their spreadsheets, including mine, are fine as far as they go. The line items have all been vetted within an inch of their lives. They’re reliable — ’til they’re not. So what do we do? Well, keep on puttin’ your boots on the ground to ensure the credibility of your bottom line. Nobody wins with a fictional NOI. Still, regardless of how hard you or I worked on a particular spreadsheet, the resulting cash flow should only be viewed as the ‘classroom’ number. When figuring annual cash flow, eschew all the hard work you spent in the field, and simply divide the Gross Scheduled Income (GSI) by 2.
In this example that’d reduce the NOI to, give or take, just under $16,000. NOW look at the interest rates above and ask yourself when you’d pass up the investment due to the cash flow — or dearth of same. Seems around 7% is the red line. Yet according to a well prepared, boots on the ground spreadsheet, 9% would be just about a break even on cash flow. That is, as long as Murphy never showed up.
BawldGuy Axiom: Murphy always shows up — it’s only a matter of when, never if. At some point it will be your turn in his barrel. Real estate investors ignore that very real fact of life at their peril.
Now let’s take a look at today’s investor rates.
Single family is at — 4.625%
A 2-4 unit property is at — 4.5%
Let’s really bring home the impact interest rates have on real estate income properties. We’ll take the NOI we’ve been using, about $19,000, and apply it to a duplex loan of around $200,000 as we did for the higher rates, earlier.
$200,000 at 4.5% = $1,014/mo — $12,168/yr debt service. That’s a cash flow of just over $6,800. Don’t forget to factor in Murphy. Doing that results in a cash flow of a tad over $3,800. (Remember: The ‘Murphy Factor’ means you simply divide the GSI by 2 to get your NOI.
What do all these numbers mean to the real estate investor in today’s market?
It means that at today’s rate of 4.5%, the investor generates more cash flow using the Murphy Factor than those who paid 7% decades ago did without invoking Murphy.
And that’s what I’m talkin’ about when referring to the impact of interest rates. Today’s interest rates will literally be the star of stories you’ll be tellin’ your kids — and their kids. That’s how low they are.
Get off the fence. Time ain’t your friend. These rates won’t last forever. The stories you’ll tell 20 years from now will either be about the low rates you paid ‘back in the day’, or about all the shoulda coulda woulda happy endings you never experienced. Your choice.
Gimme a call at 619 889-7100, and together we’ll figure out what’s up with your retirement Planning. If you’d rather write me, click the Contact BawldGuy button up top. Have a great weekend.