Jorge and Rafi discuss 4 Ways to Lessen the Impact of Rising Interest Rates on Real Estate. They discuss stress tests, leverage, and other methods.
Rafi: We’re good. You’re good.
Rafi: Good afternoon and welcome to another installment of our Graystone Brown Bag Sessions. I’m Rafi, Chief Operating Officer of Graystone Investment Group.
Jorge: This is Jorge Vasquez, CEO of Graystone Investment Group.
Rafi: And as always, we have the excellent, you know, producer of this segment, Stephany, in the background. Hi, Stephany!
Stephany: Hello guys.
Rafi: She’s back there very proud wearing her Columbia jersey. For those of you that are watching live, today, Columbia plays France in the World Cup qualifiers.
Jorge: That’s going to be a good game.
Rafi: Good luck, Columbia. I don’t know any French people so I’m going to prefer Columbia. You know, because we want to make her feel good and all that kind of stuff.
Jorge: Stephany, when was the last time Columbia
Rafi: Last time they were
Jorge: They played France?
Rafi: Oh played France, I don’t know.
Jorge: It’s been a while.
Rafi: The last World Cup they went far and they told me James so that is good. Now, Jorge, where can they find us?
Jorge: Rafi, they could always find us at Homes, the number four, income, dot, com; that’s Homes, the number four, income, dot, com where you invest
Rafi: We do the rest.
Rafi: Don’t forget to subscribe to our YouTube channel, it’s in the description over there so you can subscribe and you know watch this video. We have other videos there, too where you can basically get some knowledge. And today we have a very relevant topic. This week the Fed increased the interest rates by a quarter percent which sends ripples throughout the whole economy. The Fed from their perspective, they were trying to curb inflation, you know the unemployment rate is pretty low so that’s a way that they use especially with such low interest rates right now. That’s a way that they use to make sure that inflation is kept at a level that is manageable.
Rafi: And at the same time, you know, financial institutions, you know they make a little bit more money because of that. Positive impact for savers because now their accounts
Jorge: Savings accounts.
Rafi: Savings accounts go up by a quarter percent, negative impact for borrowers because now loans and those kind of instruments, you know, the rates go up. Credit cards, if you have a variable APR credit card, guess what, your next month, your APR is going to go up by a quarter percent. If you have lines of credit, you know, Helox and that kind of stuff that are tied to the interest rate, guess what, you’re payment next month is going to go up by a quarter percent so impacts throughout the economy, but today we’re going to focus on the impact to
Jorge: Investment homes.
Rafi: Investment homes. Real estate. How that impacts. And we’re going to talk about four ways to lessen the impact of rising interest rate on real estate investing. So we’re going to give you some perspective, things that you can do, okay, things that you should be doing either when you acquire property or when you dispose of properties or throughout your investing to make sure that the impact of rising interest rates on your investment is lower. So, Jorge, what would be the first one we talk about, the first tip of four, because we’re always going to give them four ways to lessen the impact. The first one is one that a lot of people are not that much aware of it. And the first one is stress test every deal. Now, I’m stressed today. You know, there’s a transaction I’m trying to close on that is getting me crazy. So what you telling me that properties have stress, too? What do you mean by stress testing?
Jorge: Well, you know, you don’t want your property, you want to stress test your property because you don’t want to commit suicide. (Jorge laughing).
Rafi: Say that two times. Stress test.
Jorge: Stress test.
Rafi: Stress test.
Jorge: Stress test.
Rafi: Stress test, stress test.
Jorge: So in other words, what you want to do is you want to put your property through some stress related to, can I increase the rents, eventually. Is it feasible increasing the rents if I need to, if I need to borrow money.
Jorge: Is my house going to be okay against the stress of borrowing those funds and the interest is going up. We tell investors that you surely and assets should be able to withstand six percent mortgage. So that’s how you would do your interest rate stress. Is taking your property and saying okay if the market turns down or goes down could my asset be okay with a six percent interest rate on a mortgage.
Jorge: You know, am I able to cover those payments and so forth. So that’s one of the stress that you put your property through.
Rafi: Stress test.
Jorge: Stress test from the beginning.
Rafi: Yup. Well, and this is something that you should do, guess what, before
Rafi: Let’s do it again. (break in video) You sit down and you go okay this property based on my previous lender, because you have a lender on your team already, I know I’m probably going to pay this much, the cap rates are going to be this much, the repairs are going to be this much, and you have your estimate, right, before your purchase, but then what you need to do, what we talk about when we talk about stress testing is, hey what if the repairs instead of fifteen thousand, is twenty thousand? Right, does it still make sense? What if your mortgage that you were getting at five percent, like you say, you get it at six percent, right, can you still make sense.
Rafi: What if the rents go down, instead of a thousand, you know the rents go down to nine hundred does it still make sense for you. So those are the things, those are the stress testing you basically are going worst case scenario before you acquire the property
Rafi: Because that means that hey, if things stay well you’re going to be great. Now, that’s a conservative approach. And we for example, in our calculator we’re very conservative so we estimate a month’s worth of maintenance, you know, we estimate you know five to seven percent vacancy. That’s the other one. Oh, Tampa right now, vacancy is like two percent. Guess what, we always calculate it with five percent and some properties we may make, we may say, you know what, I’m not going to buy that property, it may work with two percent vacancy but it doesn’t work with five.
Rafi: And that’s what we mean about stress testing. When you buy you need to make sure you go worst case scenario on all your factors and if it still makes sense, it’s a slam dunk. Okay, now we don’t say hey don’t buy that property. You may take a risk, that’s what investors do, that’s what we do. We take risks, but we manage that risk. So if for example you do that scenario and it doesn’t bode well, but you know that the equity is going up tremendously maybe you say you know what, I’m going to risk it because I think the equity is higher, right. But at least you did the exercise and you’re not caught off guard and that’s what we want to make sure, that you stress test your portfolio, you stress test those properties before you acquire them and then guess what interest rates go up, you know that you can at least cover. I know that you have tons of stories of people that in 2007, 2008 went belly down because they didn’t stress test, you know, their portfolio, right.
Jorge: Absolutely and this goes to the second point we’re going to be talking about, leverage.
Jorge: but over-leveraging is what got those people in trouble.
Jorge: in 2007. A couple of numbers to think of; your investment should be able to, at the very minimum be able to withstand a six percent
Jorge: Remember that number. And also your property should be able to withstand a twenty percent drop in value.
Rafi: Got it.
Jorge: Twenty percent drop in value and six percent in case you need to borrow money or get a mortgage. So use those numbers, put them to the test through the stress test to your property
Jorge: And see if is still cash flowing. That’s the best way to do it.
Rafi: And again, if you stress test it and it doesn’t look good and you still want to go for it, that’s okay because what we want to make sure is that you don’t get caught off guard. I think what happened to a lot of them in 2008, is people didn’t do that and they were caught off guard. If you do it and you know, wow it drops twenty percent, I may start losing some money, but I’m still going to go for it. You know what, guess what, that’s okay because if it drops twenty percent you knew about it, right and you can manage better versus getting surprised. And surprise is the one thing that as an investor you never want. You never want surprises.
Rafi: So that’s what we’re. I know some people may say there’s no way, I will never buy a house if I do that. We want you to manage the risk and not be surprised. That’s the thing. The second tip, the number two tip is use leverage responsibly. You need to use leverage in a responsible way. What do we mean by that Jorge? We’ve talked about this before.
Jorge: Yes, yes. So you want to leave a gap. In the ideal world you want to leave a gap of thirty percent cushion, thirty percent equity, ideally from the beginning, from day one.
Rafi: So you do that before you buy the property.
Jorge: So, ideally, in the ideal world you put a thirty percent down payment and you have that thirty percent cushion. But if you cannot do that because, yeah, I know that some people won’t be able to put thirty percent down on every property.
Jorge: Do that twenty, do that ten, but knowing that you need to shave that down, that mortgage, shave it down little by little even if it’s extra payments, principal, something.
Jorge: But it has to be part of your business plan.
Jorge: How are you going to do that.
Rafi: Absolutely. We always advocate, you know, eighty/twenty. That’s the highest that we advise our investors to go. Eighty percent you know loan to value. We actually prefer to your point, seventy percent; that we have that thirty percent, you know, cushion there in terms, if the market goes down or something like that you can actually do something about it. But, I think like the key thing here is, for example a lot of our investors buy cash first and then they re-finance, right. That’s great you have to try to make sure that the whole portfolio is thirty percent. And by the way, using the previous number that we said, hey a drop in twenty percent, when we talk about stress testing
Rafi: Well, if it drops twenty percent but you did a seventy/thirty loan, you still have ten percent. You still have ten percent.
Rafi: You still have ten percent. You still have ten percent.
Jorge: Exactly. Exactly.
Rafi: So your point, what happened in 2008, people were going ninety, a hundred.
Rafi: They didn’t stress test it
Rafi: So when it went down twenty percent they were caught with their pants down, basically.
Rafi: The other thing, and I know you’re a huge advocate of this, is if you take a refinance loan make sure that that payment always includes principle. Those interest only loans, watch out.
Rafi: Watch out, right, because to your point, you put principle it comes down, the equity goes up right.
Jorge: Well the tear is that even if you didn’t know what you were doing you bought the wrong asset at the wrong time, as long as you give it enough time, you will pay it off.
Jorge: So that’s why it’s so important that paying the principle is going to give you that safe net just in case everything else goes bad.
Rafi: Excellent, excellent. Man, a bunch of people joined, so we want to say hi to Lowe Vasquez, best photographer in the Tampa Bay area. Lowe you got to take a picture. Pose. Not two, four. Lowe, what do you think? We’re going to make it happen. We have Lowe, we have Dahlia, Mike Akia from Capital One, man long time no see. When you come to Tampa we need to hook up. We also have Marta Avera, Eddie Verdejo, Dahlia. My brother, Chef Ricardo Castro from Picante, and who else. Now do we have any questions here, let’s see. People are joining. I think they’re getting information and then they’ll go for it. Now let’s go over. Again, the first tip stress test, stress test, stress test your properties, the second, use leverage in a responsible way and the number three tip to make sure that you lessen the impact of interest rates in your real estate investment is build value to create a cushion. So we talked about, you know, leverage, but this is different it’s building value to create a cushion. What do you mean by that, how do we build value on our properties?
Jorge: Rafi, adding components to the property that are going to increase the value of the property.
Rafi: Got it.
Jorge: And this is something where you’re finding the property actually guys from day one, you might see an area where you say, “Hm, there could be a third bedroom there.”
Jorge: Maybe in two year, three I’ll do that in case the value of the property goes down twenty percent, I know that if I build this area up,
Rafi: Or make a bedroom there.
Jorge: I would make the bedroom there then I have
Rafi: Maybe twenty percent or ten percent increase.
Jorge: So, identify from day one, start improving the property as fast as you can, obviously as the rent comes in bring that value up, very important.
Rafi: I think that’s where having a contractor on your team makes a huge difference. Because when you are acquiring a property, okay, he can spot these areas where you’re going, you know what, I can add a second bathroom here, I can add a third bedroom here, maybe I can add a garage or a carport. So it’s very important that you have a contractor on your team because these things are the ones that really he can identify and he knows. You know, if you have a contractor that has worked on rental properties, you know, he knows what adds value, what doesn’t add value.
Rafi: So again, it’s very important that you have a contractor in your team.
Jorge: You know we have that investor, Gero.
Jorge: He buys properties with a car garage that he can convert eventually into another room. But obviously, it has to be in areas where they convert a car garage makes sense for the neighborhood.
Rafi: Makes sense. Yup, yup.
Jorge: You know, not a neighborhood that requires a two-car garage, you know.
Rafi: Got it. Got it. So again, how do find ways to build value okay, repair, add bedrooms, add bathrooms. Like Jorge said, you don’t have to do it right away just make sure that it’s part of your plan to say, “You know what, maybe the first year I cannot, but in the second I can add a third bedroom.”
Rafi: “I can add that second bathroom.”
Jorge: People don’t think of that.
Rafi: And not only that, it helps you in terms of equity. So there’s different ways of building value helps you. The obvious one is equity, right so if you had a three/one and now it’s a three/two, maybe before it was eighty thousand, now it’s ninety thousand.
Rafi: So that’s the easiest one. But guess what.
Jorge: Splitting lots, too.
Rafi: That’s another way, but also by adding that second bathroom or that third bedroom,
Rafi: Your rents are going to go up.
Jorge: There you go.
Rafi: So, by doing that instead of nine hundred, now your rents go to a thousand. So again, we go back to the first one of stress testing. Well again, your building, your adding to your property by doing these things. Your equity went up. Your rents go up. So that worst case scenario we were talking about, now it’s harder to happen because you have these kind of things. So this cushion is very important. Key, to have a contractor in your team that can identify these things, you know, previously.
Rafi: Now, who just joined? Um, wow. Hector Torres, Mata Herrera, Capital One again. And Demarcos Durich. Demarcos, wholesaler, right? Awesome, man. Matt Nagy the best wholesaler in Tampa joined us, too. So that’s great. Now, and then Janet
Jorge: Your sister, oh your mom.
Rafi: Janet Arana. Viva Columbia! I have to make parentheses. Janet, me dijieron que nos ibas traer arepas el lunes, asi que, esta pendiente.
Rafi: So we have a [incomprehensible] here but when you’re Janet, las espero el lunes So again, we did those things. Number four, the fourth tip, this one is for buy and hold investors like us, it’s huge.
Rafi: But at the same time, Jorge, every time I sit down with a first time investor or a novice investor, this is probably the one that they miss the most.
Rafi: You have the number fourth tip make sure you have a long enough runway and by that we mean don’t plan if you’re a real estate investor, when we say long term we really mean long-term, right.
Jorge: Yes absolutely. I think this is another layer of protecting yourself.
Jorge: Making sure because we don’t know, we don’t have a magic ball, a mirror ball
Jorge: However you call it to be able to tell the future, so we don’t know if the market is going to turn next year, or five years from now, but if you do your mortgage loan the right way, long-term, ten, I’ll say ten years minimum, ideally but seven to ten.
Rafi: The risk covers at least five you know at least five but definitely the goal ten if you can.
Jorge: And the idea behind it is you’ve done your improvements.
Jorge: in five years, seven years whatever the case may be. You’ve paid some principle.
Jorge: So you’re hedging there, hedging there and hopefully if the market turns five years from now, you’ve paid enough down that now you’re in a safe spot to let the property go if you have to sell it or do whatever. More options for you at the end.
Rafi: Well you think about it if you made a loan, let’s say in 2007, right before the crash,
Rafi: 2007 and you did a ten-year loan,
Jorge: Uh-huh. Uh-huh.
Rafi: Guess what, if you dispose of the asset now, (laughing) you’re going to be fine. We have an investor, Tony, what’s up that bought right prices were very very depressed, right.
Rafi: He bought at that time, a ten-year loan, now you refinance and guess what you refinancing a fifty-thousand dollar property that you bought back then, now the price you know is probably a hundred-thousand because if you bought cheap at that time, especially in the Tampa Bay area, you’ll probably double your investment, right.
Rafi: But if he had a three-year loan and he had it since 2011, guess what.
Rafi: He probably would have lost
Jorge: Well, Rafi, I’ve got
Rafi: a lot of money
Jorge: I’ve talked to several investors that bought before 2007, 2005 and 2006, that bought at the highest peak possible
Jorge: They are now telling me that they are actually in the black now.
Jorge: After. Why? Because they paid some principle. They had a fixed thirty-year mortgage, the property values started valuating more.
Rafi: And maybe they’re just catching up with that original price.
Jorge: And they only have left fifteen years on the mortgage.
Rafi: Uh-huh. Uh-huh.
Jorge: And as we know, mortgages at the beginning is everything towards interest.
Jorge: Interest. So, he’s ahead even as it is.
Rafi: Right. So having that long runway is the key that has to be part of your portfolio, something that when you look at every year because every year you need to make sure that you take a look at your portfolio. You make sure you have that flexibility and hey the exercises that you have to do, these are exercises that we do for our own properties at the beginning of the year look at what’s due that year, right. What are the properties that your loans are due on that specific year and then plan on what you are going to do. Some properties, guess what, we’re going to sell because based on the appreciation, based on the loan that we have, you know based on the rents and you know the conditions of the property, the best thing right now is to sell that property. We have some other properties that we made that same analysis and we say you know what, the rent if very good, the cap rate is very good, it makes sense to put a new roof or something and you keep it. So, but the good thing is that we can do that because we have that long runway, we have that seven-year plan, okay and we have that seven-year plan you give yourself flexibility in terms of what you do, so. Let’s go over the four tips again just to make sure. The number one tip, man, this word, stress test your properties. Make sure that before you buy the property you stress test it. The number two is use leverage responsibly, seventy/thirty.
Jorge: Uh-huh. That’s what
Rafi: Eighty/twenty max. No nineties, no hundreds. Eighty/twenty is your max. If you’re watching this video I know that you’re going to stick to that seventy/thirty, eighty/twenty max. The third tip, number three, build value once you buy the property, okay. Repairs, adding bedrooms, adding bathrooms, garage.
Jorge: Also identify that from day one as you’re looking for properties.
Rafi: Absolutely. We’re just buying some lots.
Rafi: But the reason we’re buying them is that they can be divided.
Rafi: So, so if it was one lot, we probably would not buy it.
Rafi: Most likely. But we identified that opportunity to create value by splitting the lots. Yeah, they may be smaller lots, we get it. It’ll be tighter, we get it. But we think we can put two houses and create value.
Jorge: Perfect sense.
Rafi: And the number four, the fourth tip is give yourself a long enough runway, right. We advise at least a seven-year plan when you know you have it, when you’re going to have a loan we recommend at least a ten-year loan, but bare minimum five years so that you have some flexibility. Actually, we just had an investor that wanted to sell something but because of pre-payment penalty, it was too early so he decided not to.
Rafi: So those are the kind of things that you want to have. By the way if you’re looking to refinance or cash out on your properties you can contact us and we’ll help you with that and it’s something that we definitely can help you with. But again, these four tips, now that the interest rates went up, the smart investors apply these tips. And by the way, you can still do it, building value, you can do it right now. This is something that if you didn’t do it when you bought the property, you can apply some of these things, some of these tips and make sure that you’re better. The stress test you can do it even after, we recommend before, but even after you can sit down and go “Wow! I listened to these guys with sunglasses, they said to stress test. Let me do it to my current properties. What would happen?” That way you’re not surprised. So don’t think that you have to do it always before. You do it right now at least you know where you stand.
Jorge: The extra benefit is that your tenants will be happier that you’re constantly improving the property.
Jorge: Take care of it a little more.
Rafi: Exactly, exactly. So, uh, Stephany do we have any questions? Man people have been shy in the last couple of times. We want questions, people.
Jorge: Come on, guys.
Rafi: Ask us questions.
Jorge: One question.
Rafi: We want to be challenged. We want you to think that we don’t know it so that you can send it to me, and we do know it. Or we’ll make our best to show that we know it. Or even better, we’ll tell you, “You know what, we don’t know it, we’ll get back to you and we’ll send something in there.” So, again, four tips to lessen the impact of rising interest rates on your real estate investing. Jorge, where can they find us?
Jorge: They could always find us, Rafi, at Home, the number four, income, dot, com; that is Homes, the four, income, dot, com. Where you invest
Rafi: We do the rest. New location.
Rafi: I forgot to say it.
Jorge: That’s right.
Rafi: We moved to a new location so if you see things a little bit different, it’s the first time we do it here so if you see that I’m too much to this side or too much to that side we’re still trying to figure out. Give us feedback if you think that it’s too loud or too close, whatever and we’ll go from there. So, thank you so much for joining today. We had a lot of people join today.
Rafi: That’s awesome. Don’t forget to share this video in your network so that they can join us the next time. Next time, are we going to do the next time from the NetZero building?
Rafi: Maybe we’ll do it from the NetZero building that we have over there in St. Petersburg. You stay tuned and don’t forget to subscribe to our YouTube channel.
Jorge: We’re at eighty-four, giving away
Rafi: When we get to a hundred subscribers, every time we get to a hundred, two hundred, three hundred, we’re going to give a hundred dollars in gift cards and when we get to a thousand subscribers, we’re going to give out
Jorge: A house, no just kidding (laughing).
Rafi: Laughing. We’re going to give out a thousand dollars in gift cards and a little tiny house in foam, one of those little stress test, one of those (laughing). Want to thank as always, Stephany in the background. Thank you, Stephany.
Stephany: See you, guys.
Rafi: Viva, Columbia, they’re going to win today. Papita nos dio the prediction, two to one Columbia today.
Jorge: Yeah, yeah.
Rafi: Papita from Mary’s Café. He said dos-uno. I believe him. We’ll see you next time in our next Graystone Brown Bag session.