Record-low mortgage rates have made real estate more attractive, but with so many other economic uncertainties, is now the right time to plunge into the real estate market?
“The age-old question of when to buy real estate is being asked more frequently now than pre-pandemic,” says David Tuyo, CEO of University Credit Union in Los Angeles. “As many Americans are faced with employment and economic uncertainty, near-historic-low rates make home purchases very appealing.”
With the economy in a recession due to the coronavirus and millions of people unemployed, some potential investors are wondering what they should do. And low interest rates are not all good news for buyers either. While low rates may make a property affordable at first, sellers can also raise their asking price to capture some of the value created by low rates.
That’s just one of the things you’ll want to consider before you invest in real estate.
6 things to watch as you’re investing real estate
1. Are you investing to occupy or rent out?
Investing in real estate could mean buying to occupy it or to rent it out. That may sound like a trivial distinction, but it’s important in how you think about your purchase and how it’s financed.
If you’re buying a property because you plan to live there, consider whether it makes sense to actually buy rather than rent. Will you be living in the area long term so that it makes sense to lock up your money in a down payment and pay the closing costs and other transaction fees? Many experts suggest that you have to occupy the property for at least seven or eight years for it to really start making sense to buy.
If you’re an owner-occupier, you’ll also want to consider how big a house you might need in the future. Will your family expand soon and require more space? It may make sense to buy a bigger house then you need now and lock in a low mortgage payment for years.
If you’re buying to rent out, your considerations are different. It’s about how much money the property can generate. So you need to understand the rental market as well as the expenses of maintaining the property. In addition, you’ll likely have to put more money down, often 25 or 30 percent, than if you were an owner-occupier, where 20 percent (or even less) is common.
“Investors need to be aware of the unemployment in the area of their investment properties,” says Tuyo. “You obviously want to hedge your bets that tenants will be able to pay rent as much as possible. If the property is in an area… deeply impacted by the pandemic, it might not be a good short-term play.”
“So far, so good,” says Gary Beasley, CEO at Roofstock, a real estate platform based in Oakland, California. “Most owners are reporting rent collections largely in line with pre-COVID levels.”
Regardless of which path you go, you’ll want to know how much house you can afford.
2. Low mortgage rates
Mortgage rates are at historic lows, and now some lenders are even offering 30-year mortgages below 3 percent for owner-occupied housing. It’s hard to see such low rates and not reach for your checkbook, if a house already makes sense for you.
Such low rates may make owning a house more affordable than renting one, depending on your circumstances. And with the mortgage likely being the single highest cost for a homebuyer, low rates are definitely going to drive purchases.
But rates can cut both ways, too. If mortgage rates rise in the future – certainly a big “if” in the short term, as the Fed has promised to keep its rates low through 2022 – then it could hurt house prices. But with low rates making homes more affordable today, buyers may see a future rise in rates as something worth worrying about when it arrives, if it ever does.
3. Homes are more affordable, or are they?
Low mortgage rates may make property initially more affordable, but they may also send house prices soaring, negating the effect of low rates. This effect may be compounded by low inventory in some areas, making buyers scramble for what houses do remain available.
For example, take a $100,000 30-year mortgage at 5 percent interest. The fully amortized monthly payment would come to about $537. With a rate at 3.5 percent, the new monthly payment would be $449. If you were simply refinancing that, you would capture all the value.
However, when sellers see that homes are more affordable due to low rates, they may raise their asking price. At a rate of 3.5 percent, the same buyer could now afford a $120,000 mortgage and pay about the same monthly payment ($539) as before at the higher rate.
Here sellers may account for lower rates by raising asking prices by up to 20 percent. Not only does the rise negate the lower mortgage rate, it also means the buyer must come up with more money down. However, in the real world this process doesn’t happen instantaneously, so buyers may still have time to get real value before the market fully reflects the effects of low rates.
Depending on the circumstances, low rates are not always the cure-all they seem to be.
4. Watch out for a hot market
“There is never a wrong time to buy a house, or an apartment or land,” says Jessica Levine, a real estate broker at Douglas Elliman in the New York City area. “Rates are once again at all-time lows, buyer sentiment is strong and the level of pent-up demand at the moment is quite high.”
More circumspect buyers – and those who don’t have to buy today – may be dubious of such claims, however. The market forces pushing up prices now rarely last long term, because the housing market responds to incentives, such as low supply, and adjusts. That said, real estate investors need to be looking at long-term trends, not just whether the market is hot today.
“Residential real estate is increasingly being viewed as a safe haven for both investors and owner-occupant buyers,” says Beasley. As key factors for the rise in prices, Beasley names low rates, a shortage of inventory, the increased focus on a residence as work-from-home becomes normalized and investors’ concerns about other real estate sectors such as office and retail.
Yet despite the economic uncertainties – tens of millions suddenly unemployed, for example – the market remains surprisingly robust, though it does depend on the area.
“Have the prices come down tremendously? No, not at all, because there is still hope that things will change for the better,” says Alina Trigub, managing partner at SAMO Financial, a real estate advisory in the New York City area.
“In Florida, prices have held firm but many other markets in the U.S. are buyer’s markets, making it an opportune time to invest in real estate,” says Chris Franciosa, principal agent at Compass Real Estate in Delray Beach, Florida.
“In the intermountain west, investors continue to pour in,” says Lee Gientke, managing partner at Pontifex Capital, a real estate developer in Boise, Idaho. “Investors are typically moving money away from coastal cities – San Francisco, Seattle and Portland – and into lower-cost, lower-regulation, high-quality-of-life intermountain states like Idaho, Montana, and Utah.”
5. Check your financial situation and ability to make payments
A big investment in real estate requires you to have a solid financial position. If you’re owning to occupy, then you’ll want to ensure that you’re able to make the payments, while landlords want enough cash to make repairs and cover a mortgage, if a tenant is unable to make rent.
Tuyo suggests it’s a good time to buy if you have job security and find a home you want.
However, even a temporary disruption to your income may not hold you back, says Franciosa. “Lenders are aware of gaps in employment and want temporarily furloughed buyers to know it doesn’t preclude them from qualifying for a mortgage,” he says.
But given the uncertainties, those looking to invest in real estate can be more conservative in both how they finance a property and what kind of property they do buy.
“The most important lesson potential investors can take away from the COVID-19 quarantine is to be more conservative with their use of leverage and to maintain higher cash reserves so they weather any sort of tenant default issues,” says Gientke.
In uncertain times, It’s good to stick with industries that fall within your “circle of competence,” says James Richman, CEO at JJ Richman, an asset manager. “It’s much easier to understand industries and areas that you’ve had exposure in as opposed to trying to decipher new and upcoming industries that you may not have exposure and expertise in the past,” he says.
6. Make passive investments in real estate
While many people hear the words “real estate investing” and think of high-ticket houses and apartments, investors can also get started in many other ways that offer attractive returns. One of the most popular is by being a passive investor in real estate.
Such passive investing includes buying a stake in a real estate investment trust, or REIT, and using an online platform to invest. Both approaches avoid the headaches of owning and managing the physical property, and they offer other advantages, too.
For example, by investing in a publicly traded REIT you can start out with as little as $20 or $30, depending on the price of the REIT. There are no commissions on trading your investments, unlike the substantial fees for real property. Plus, the investments are usually incredibly liquid and typically pay regular quarterly dividends, without you having to manage a property in any way.
(Here are five ways to invest in real estate, including how to maximize profits on each.)
Despite the uncertainties created by the economic climate and the coronavirus, real estate may still prove an attractive investment today, in part due to historically low rates. But remember that a lot of the value of investing in real estate comes in the long term, holding a property and letting time grow your investment. Investors looking to make a short-term score are often disappointed.
Featured image Ariel Skelly of Getty Images.
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