The big news the last few months has been the historic rise in interest rates set by the Bank of Canada. These increases have heightened buyer uncertainty and have even caused discussions of a coming recession. As a real estate investor, should you get out now while you still can? Should you hold your capital on the sidelines and wait things out? In this post I will share how I think about rising interest rates, and why most investors I know are still buying (myself included).
In times of economic downturns, real estate investing fundamentals become increasingly important. You must calculate your financials with conservative figures, ensure every deal cash flows positive, and focus on the microeconomies that are still thriving. If you do, the pending recession could be the buying opportunity of the decade!
How do you find a deal with all of this economic uncertainty? Read on and I’ll share what I think of the market, and how to make sure you land a home run on your next deal.
See rising interest rates for what they are
First, remember that the Bank of Canada (similarly, the Fed in the US) can only be reactive to market conditions at play in the country. The BoC determines policies based on what they see on a macroeconomic scale - using indicators like inflation, employment, cost of living indexes, etc. Since the start of the pandemic, two factors have been at play. First, governments across the globe have increased spending to historic highs never seen before. Not to mention, they keep spending more. And more. This injection of capital into the economy can do only one thing - increase consumer spending, which increases demand, and therefore increase prices to boost inflation. Second, the supply of consumer goods is still very low, and will take much longer to recover from the impacts of the epidemic. These two factors combined mean that prices are just going to keep climbing.
With these factors in mind, the Bank of Canada can only try to do one thing: increase interest rates and (hopefully) discourage demand. This can work to a certain extent, however will not fix the external supply side forces at play. So will it impact inflation? Yes, but it won’t fix the whole problem in this unique economic state that we have found ourselves in.
Don’t fool yourself with slim margins in your analysis
As an individual investor, what can you do about it? First, run your numbers with increasing interest rates in mind. Just like the banks stress test to validate your ability to qualify, you should be running your numbers with your own “stress tests”. Run your numbers with interest rates at least 2% higher than the current posted rate. Does the property still cash flow positive? What if you add 4% on top of posted rates? 6%? You should know exactly how much of an interest rate change a potential property can handle before you start to hit red.
Second, do not overpay for a property. Increasing interest rates do have a direct impact on housing affordability, and it does place downward pressure on home prices. You’ll need to do your diligence and really understand the market comps, even if the theoretical cash on cash return is there. The market must also show evidence that is strong enough to maintain relatively low vacancy rates. You can validate this by checking employment, tourism demand, population growth, etc. As always, make sure your deal is in fact a good deal.
Real estate markets are local. Really local.
The real estate market in Toronto is incredibly different than the market here in Calgary. And the market in Vancouver is different yet again. Over the last few years, the housing market in each of these areas behaved quite differently. Although we only saw modest appreciation in Calgary (relatively speaking!) to the GTA, Calgary is likely to see a much smaller (if any) price correction in a potential downturn as a result. This is where it really pays to know your specific market. I am laser focused on the areas directly surrounding the Calgary area, and within that, have narrowed it down further to very specific municipalities. And even within those municipalities, I’ve narrowed it down to very specific property types that I am analyzing. It really does pay to have that specialized market insight. You have to know your specific market and the forces at play in its own specific economy. When you have that level of specificity, you be able to confidently identify a great opportunity when you see one.
This will be the best buying opportunity in a decade
Most of the seasoned investors I know are still buying. They have the experience to see a downturn as an incredible opportunity. They run their numbers, understand what makes a good deal, and commit to winning in the long run (real estate is hardly a get rich quick scheme). For all of us, we have to look for those great individual markets that still have incredible opportunity for growth, and find those deals that are winners. Like Warren Buffett famously said, “be fearful when others are greedy. Be greedy when others are fearful”. That statement is more apt now than ever.
What about you? Are you still looking to buy? Are you sitting on the sidelines? Would love to hear your thoughts!
