Recent data from the Bank of Canada shows that inflation is rising higher, and that means that we can expect interest rates to rise sooner rather than later. The most recent inflation rate of 3.7% is the highest it’s been in eight years, and is well above the 2% level that the Bank of Canada is required to keep inflation at.
This key indicator effects nearly the entire economy, and is especially important to landlords for several reasons:
The Bottom Line Takes a Hit
If you have a variable rate mortgage or plan to refinance any of your properties in the near future, then you may face higher debt burdens, which means nothing more than less money for you and more for your lender.
I read a great article over at milliondollarjourney.com written by Ed Rempel titled Avoid the 5-Year Fixed Mortgage Trap that discusses why you should use a variable rate loan to finance your properties. It specifically discusses how a variable rate mortgage is still cheaper than a fixed rate mortgage because the fixed rate mortgage often starts out higher. That said, you’ll still end up paying more than you used to once rates get hiked.
I would caution that if you’re highly leveraged on your property, as many beginning real estate investors are, then a variable rate mortgage could turn your positive cash flow negative.
Erosion of Market Value
Higher interest rates for loans mean investors require higher rates of return on their capital. To a real estate investor, this rate of return is the cap rate, and the cap rate, as we know determines the value of an investment property. If your property generates net operating income (NOI) of $30,000 per year, then the market value of your property at a cap rate of 10% would be $300,000. If interest rates were to rise, investors may begin to require a cap rate of 11%, making the value of your property $30,000 / 11% = $272,727. This might be an extreme example, and it probably wouldn’t happen overnight, but the potential is there for devaluation.
Your Tenants Stay Longer
As the cost of borrowing for real estate investors rises, so does the cost of borrowing for your tenants. Tenants that were saving to purchase their own home will have to save a little more, and stay a little longer, in order to afford that new mortgage. The downside to this is that their other debt will become more expensive also, and may lead to higher vacancy and delinquency expenses. The latter should not be as much of a problem if you’ve properly screened your tenants.
I think it’s safe to say that interest rates will rise, but it’s tougher to say when or how they will rise. Having an idea of what effects higher interests may have n you allows you to make a plan that makes rising interest rates take the smallest toll on you.
June 2011 marks two important milestones for me: (1) I bought my first investment property five years ago, and (2) I started canucklandlord.com one year ago.
Like most endeavors, I started out on both of these journeys with a set game plan that gradually evolved as I went along. As I started to implement my plans, situations came up that I didn’t foresee and I had to tweak my plans to compensate.
When I bought my first investment property, a three unit residential, I had the romantic notion I imagine every new real estate investor has: buy a property, do a few repairs and upgrades, get some low-maintenance tenants in there, and sit back and watch myself get rich. Reality, she is a bitch.
Being a landlord is not that easy, and I should have known better. After all, I read many books on how to be a landlord and manage rental property. The good ones all warn you of the pitfalls. I guess I thought that since I knew what the pitfalls were, I would easily avoid them. What you quickly learn once you buy an investment property, is that being a landlord is a job, and it’s not an easy one. Simply knowing what the pitfalls are is not enough. They are well hidden and only experience teaches you how to spot them.
You WILL have bad tenants despite your best efforts, and they WILL take advantage of you if given the chance. You WILL have emergencies, and they WILL NOT happen at convenient times. All of this WILL cost you money if you do not properly plan for these contingencies.
If you are cautious, frugal, and hardworking, you WILL be rewarded. The rewards are when your good tenants acknowledge your hard work. The best days are when one of your tenants refer to their apartment as ‘home’. I haven’t sold any of my own properties yet, but I imagine that will be another high point of my career. That’s the drug that keeps you coming back.
Similarly, when you start out creating a blog, you have these visions of thousands of people reading your daily posts, and sharing them with their friends. Perhaps even one of the other types of media picks up on it, and even solicits an opinion from you, citing you as an expert in your field. Alas, the reality is that there are few, if any, responses to your first few posts. But then, somehow someone finds your blog. Then a few more people start finding it, and one person even leaves a comment. You let your friends know what you’re doing and a few more people are reading it. Your Google Stats are getting better, then worse, then better. You watch them like a day trader.
As the excitement of the new venture begins to wane, and the constraints of having a full-time job and a part-time business begin to pile on you, it becomes harder to churn out the content you did at the beginning. Your daily posts start to be weekly posts. Some days you have to force yourself to write, other days are easy. Every now and then you become inspired to post something that gets big results and it renews your enthusiasm in it. When you check your Google Stats and it shows a big spike in hits… that’s the drug that keeps you coming back.