In this
video, I'm going to talk to you about why I believe that rising interest rates
are going to create a tsunami of problems for many real estate investors.
And a lot of people that are invested in a lot of projects.
So for all of you naysayers who think this is just click bait, argue
with the facts, there's five, five, count them five.
Interest rate increases from March of this year.
And here they are right here in order.
So you can see you cannot argue with the fact.
So the result of this is that people can't afford housing
and their mortgage payments have gone up over $1,000 a month in many cases.
What's not being talked about much are the people that are buying
investment properties and how these rates are affecting them.
And that's what this video is going to go into next.
Before we go into the next slide, I want you to know
that we're not quite done.
There's two more rate increases.
And if inflation doesn't come down by the end of the year, they'll be more
in 2023.
Now, in a period of just a few minutes, I found all these articles
showing how interest rates
are impacting people and they're impacting everyday people
for student loans, credit cards, auto loans, mortgages, all that kind of stuff.
It's everywhere.
And of course,
if you guys aren't looking at this stuff, then of course your head is in the sand.
But these big rate increases are causing problems for many people,
not just real estate investors.
What I want you to pay attention the most is this one here where it says
the Federal Reserve's increasing interest rate hikes have put Main Street.
That's not Wall Street. That's Main Street.
That means everyone,
the economy, dangerously close to the edge of a lending cliff.
And this is what we're going to talk about today is debt.
What this is doing to people's debt, specifically with real estate investors.
In the past few years,
most of the real estate investors have put out deals that said, hey,
we're going to buy this project, we're going to increase the income
and we're going to reduce the expenses, and we're going to grow the net
operating income and all is going to be fine.
And oh, by the way, we're going to put a loan on it
and then we're going to cash out, refi or sell later
and we're going to make all this money.
And that's how most deals are pitched.
And while everyone was busy focusing up here,
this is actually the problem at the moment is the interest rates have gone up
and the cost of debt has gone up or many real estate investors.
This is going to be the death of them.
Now we're going to look at three components of debt.
One is the type.
So that would be a fixed or say, a variable rate.
The second would be the rate has have rates been at 4% or 6% or 5% or 3%.
And the third one is the term.
Is it monthly?
Is it one year, two years, three years or longer?
So those are very important things we're going to talk about next.
And depending on the type of debt or terms that you've negotiated for,
your particular deal is going to vary widely on how that deal performs next.
So now let's take a look at just a $1 million deal that somebody might buy.
So now we're just going to focus on the debt piece, of course,
and we're just going to assume that everything's
fine on the income and the expenses and you might even have a value add going on.
But the debt is what we're going to discuss here,
and that could wipe away all your value.
Add that you get a lot of the deals that you might have invested in
are going to focus on the income and expense side.
In other words, they're going to say, hey,
we can buy this property and it's a value add.
And value adds are largely going to have adjustable rate mortgages
because what you want to do is you want to capture that value
and then put a fixed rate loan on it later.
So in other words, you don't want to put a fixed rate
loan on it now because you might have a big prepayment penalty later.
So you put these bridge loans or variable rate loans on
while you're doing all the work, you're growing the value.
And the idea was to do a cash out refinance using more debt.
That's the model
that a lot of deals were done doing and a lot of people invested in.
So the problem, of course, is that debt has gone up.
So in this scenario, I just use $1,000 investment,
but the $200,000 down payment at a 4% rate, as you could see,
the actual mortgage payment is about 3800 bucks.
And as the rates went from 4 to 6, as you can see in this scenario,
that means that the actual payment has gone up
$1,000 a month or $12,000 a year.
And why that's important is because these rates have only gone up 2%.
The same mortgage, the same loan amount.
So what that is going to do to cash flow, it could put a lot of these deals
into a negative cash flow situation.
So that's just on a deal of $1,000,000.
So now let's look at a $10 million acquisition with a 20% down
at a 4% rate, which, by the way, could have just been a year ago.
At the time, the monthly payment would be right around $38,000.
And as you can see from just six months in five rate increases, rates
have gone up to around 6%, putting the mortgage payment of around $48,000.
So, again, $10,000 a month or $120,000 a year.
My guess is a lot of
this is going to wipe out the cash flow, even puts you in a negative situation.
All things being equal here, maybe
you've grown the income, maybe you've reduced the expenses.
So maybe you've captured this increase of debt, but maybe not.
And that is actually what I think a lot of people are unprepared for right now.
So the question is who's
going to be most at risk and who potentially could go broke,
losing all of their money?
And I broke it down to four things.
One, adjustable rate. We talked about that.
So if you had a 4% rate, let's say one year ago and now they're six,
that means your mortgage payment has gone up each and every month
and your cash flow has gone down each and every month.
The second one would be if your terms are expiring.
So that would be a loan maturity or something that was rather short term.
And of course, again, it's adjusting to the new rate
because you're entering into a new term and you're at risk
because your debt costs will go up and your cash flow will go down.
The third one would be on rate caps.
So when you're getting a loan,
you can buy an actual rate cap, you can hedge it like an insurance policy.
And this is what we did on all of our short term debt, our three year debt.
We put rate caps on our SO we have rate caps
through the middle of 2024 on a lot of our deals.
So we're hedging our rates at the time.
My partner and I, Ross, because we were experienced,
we said we better put these on just in the event
that rates are increasing and a lot of investors did not do this.
So many investors, monthly debt costs are going up so fast, much higher than rates.
And the lowering of expenses are and their cash flow is getting eaten away
and might even be negative.
The fourth one is going to be around cash reserves.
Now, most prudent, experienced investors are going to have lots of cash reserve.
You guys all know that Ross and I went to six months of cash reserves
when the pandemic hit. We're right.
We're at three now. We're at six.
And now lenders are starting to do 50%
loan to value and they're making the syndicators
and the GP's or general partners put up even more cash for loan reserves.
This is a very important thing and this potentially is something
that you can ask as a limited partner or as a general partner.
You need to make sure that you're putting lots of cash reserves down
because the last thing you want to be doing is having more interest rate risk.
Because remember,
we have another Fed meeting in November and then another one in December.
And so these rates could go up even higher and your cash flow could go even lower.
So you need to make sure that you're managing these debt costs,
especially if you're handling other people's money.
This is a very important thing, and so is this.
And you need to be very transparent on what's happening.
We already have some of our more
sophisticated investors asking me this very question.
Did you guys buy rate caps?
Where are your rates? What's your cash flow look like?
Are your projections
consistent with what you said they were going to be in the business plans?
These are all things that a limited partner should be ask, could be asking
and will be asking.
If you're not prepared for this, you better be careful
because you might be facing not being able to refinance or even sell these deals
if you run out of money and people are going to be coming after them later
at deep discounts.
The last
thing you want to do here is wait, because the Fed is battling high inflation
and it looks to me like we're going to have continued
rate increases into the future, which is going to drive
many of these deals into more and more negative cash flow.
And you're going to be faced with a cash call or have to force a sale
or you won't be able to cash out, refine your investors are going to be very,
very, very unhappy.