how to invest in real estate with high interest rate

As we are all aware, the cost of borrowing for real estate has been steadily rising since the beginning of 2022. As of September 2023, the 30-year mortgage rate has exceeded 7%. Initially, when the Federal Reserve announced quantitative tightening measures to combat rising inflation, many people believed that real estate prices would fall. However, today, in most parts of America, real estate values remain high, primarily due to a lack of resale properties on the market. So, in this current high-cost environment, how can you still profit from real estate?

There are various ways to make money in real estate. For a buy-and-hold real estate investor, there are generally two primary avenues for making money: cash flow and appreciation. However, for new investors, especially in markets with high borrowing costs, achieving positive cash flow can be challenging. In many large, rapidly growing metropolitan areas, rental properties may only offer a 4-5% capitalization rate, while in rural areas or metro regions with declining or stagnant population growth, the cap rate might be in the 7-8% range. With borrowing costs at 7%, there may be little to no cash flow. So, how can you make real estate investments work in this environment?

1. Cash Purchase: With the increase in mortgage rates, an increasingly large percentage of properties are being purchased without financing. Since the cost of loans is prohibitively high, some investors choose to pay for properties in cash to generate positive cash flow. While this eliminates the advantages of leverage that allow for quicker scaling, buying the right property in the right area can still yield a 7-8% return on investment, which is higher than the 4-5% return offered by banks or bonds.
2. Increase Income Potential: Another approach is to maximize a property’s income potential. For instance, converting a long-term rental into a short-term rental or Airbnb can significantly boost revenue. Properties near hospitals, nursing homes, or assisted living facilities often have strong demand for short-term rentals by travel nurses and visitors. Similarly, properties near universities or large sports facilities can be converted into Airbnb units to attract visitors attending events.
3. Rent Increase: In a high-inflation environment, rents tend to rise along with other costs. The pace of rent increases varies across markets, with some reacting more swiftly to inflation. Identifying areas with potential rent increases or simply purchasing property in your local market and waiting for rent to rise in the coming years can lead to a significant improvement in your cap rate.
4. Small Commercial Deals: Many people believe that commercial properties are exclusively for large corporations, but that’s not true. While I wouldn’t recommend that a new investor or someone just starting in real estate jump into the commercial real estate realm, seasoned investors can find numerous small commercial properties to add to their portfolio. Commercial real estate is often valued solely based on its return on investment (ROI) or capitalization rate (cap rate). In a rising interest rate environment, with higher no-risk returns (e.g., 10-year US Treasury yields), the expected return in commercial real estate also rises, potentially making it a viable addition to your portfolio.

These strategies illustrate how, even in a high-cost borrowing environment, you can still find opportunities to make money in real estate. It’s essential to carefully evaluate your investment goals, risk tolerance, and the specific market conditions before deciding on the best approach for your real estate investments.