When investing in real estate, remember: low interest rates tend
to help Sellers more than Buyers.
It might seem counter-intuitive, but that really is the lesson
from the "bubble years." Low interest rates seemed to cause
temporary insanity in Buyers. (Low rates also increases the
number of Buyers as it makes the product look more affordable.)
Overpaying for assets, because financing was so cheap and
because there was now new competition bidding asset prices up,
became so common in 2002-2006, that the market assumed the
higher valuations were the natural order of things. Oops.
Suppose an investment property will support a monthly
payment of $5,000;
-at 10% interest that payment amortizes a mortgage of $465,000
-at 8% interest that payment amortizes a mortgage of $523,000
-at 6% interest that payment amortizes a mortgage of $592,000
Investors who focused more on how much they could finance,
instead of what was the underlying cash flow was really worth
by traditional standards (i.e. cap rates in the 8% to 11% range),
tended to overpay and overborrow. A bad combination for
everyone but the Sellers.
(for a quick reveiw of, and one person's opinion about, cap
rates please detour to
here.)
The amazing thing is that, even after the carnage caused by
real estate investments made at historically low capitalization
rates in the 2002-2007 era, big time players are still willing
to buy investment property in the "gateway" city markets at
cap rates below 7%.
The prediction here is that ten years from now those Sellers
will still be chortling about their good fortune while those
Buyers will understand the meaning of remorse.
There is money to be made today by investing in real estate.
We encourage it. We are doing it. However, a little prudence
and a little patience will go a long way towards the story
having a happy ending.