Why Rental Properties Are Still A Good Investment Even With Higher Interest Rates

Published online: Sep 20, 2022 / Property Owners

It’s no secret that recent mortgage interest rates are on the rise. If you are hesitantly looking to purchase a rental property amid the current interest rates, you are not alone. There are many factors that go into determining if a rental property is a good investment. We’re here to explain why—even with interest rates on the rise—rental properties can still be a lucrative investment.

History of Mortgage Interest Rates

Over the last 10 years, we have been spoiled with some historically low interest rates. In fact, mortgage interest rates hit their lowest rate in over 50 years in 2021, with rates as low as 2% for some buyers. During the 2010’s, we were seeing rates typically ranging between 3%-5%. Prior to that, rates spiked in the early 1980s with interest rates as high as 18%. By the 1990s, the mortgage rates settled to a range between 7%-10%. When you consider the bigger picture, it’s true that mortgage interest rates are rising, but they are rising from the lowest point they have been in recent history. A higher interest rate is no cause for alarm when we are still talking about rates in the 4%-7% range.

Supply and Demand of Purchasing and Renting

Higher interest rates have the potential of leading to better deals when purchasing a rental property. When interest rates increase, the demand to buy typically goes down, leading to a shift in the market from a sellers' market to a buyers' market. In a buyers' market, prices tend to level out, and in some cases, they even drop. Additionally, you are far less likely to be competing against other buyers—or against as many buyers—when you make an offer on a property.

Even though you may be paying a higher interest rate, because you can score a better deal on your rental property, you may end up saving money when all things are considered. In some cases, higher interest on a lower purchase price will be cheaper than a lower interest rate on a higher purchase price.

For example, if you purchase a property for $350,000 and you get an interest rate of 3.75%, your principal and interest payment will be approximately $1,620. In a buyer’s market, you may be able to purchase that same property for $300,000. If you are paying a higher interest rate of 5% on that lower price, your payment is going to end up being about $10 lower at about $1,610. Again, it’s important to look at the bigger picture and take all of the numbers into consideration when determining if a property is a good investment.

On the flip side, when the demand for buyers to purchase homes goes down, their demand to rent goes up. Tenants who may have been looking to purchase a home decide to hold off on buying and continue to rent, causing rental rates to increase and vacancy rates to decrease. All of these things are great news for rental property owners.

Rental Properties as Investments

The ability to provide both short-term and long-term ways to build wealth makes rental properties profitable long-term investments. While monthly rental income can provide a steady revenue source short term, equity building and property appreciation can further build wealth in the long term.

Rental Income

Ideally, you will have a positive cash flow when investing in a rental property; meaning the rent prices would be higher than your mortgage payment, taxes, insurance, repair and maintenance costs, and property management fees combined. Even if you are breaking even on what you are charging for rent (and in rare cases, even if you are cash flow negative), a rental property can still be a good investment. Although you may be breaking even now, consider future rent increases that can lead to future cash flow, or increases in cash flow. Historically, rent rates have increased every decade since the 1950s, and continue to rise.

Equity

As you make your mortgage payment each month, you are building equity. If you are able to cover your payment with your rental income, then your tenants are building that equity for you. And that is only considering that the market value of your home stays the same over time.

Appreciation

Historically speaking, property values are known to rise in the long run. Not only are you building equity by having someone else repay your mortgage for you, but the value of your property will appreciate over time as well, increasing your equity at an even faster rate than what you are paying back.

*It’s important to remember that we can never predict the future, but we can make educated predictions based on past trends.

Long-term Thinking

Rental properties make great long-term investments. In addition to the income, equity, and appreciation gains, there are other financial benefits that come along with owning rental properties.

Tax Benefits

It’s important to consult with an accountant or financial advisor for specifics on tax law, but there are many tax benefits that come along with owning rental properties. Although you may be paying more in interest with the higher rates, interest paid on a mortgage loan is tax deductible, along with property taxes, depreciation, repairs, and other operating expenses. If you currently own a rental property and are looking to purchase another one, we would recommend consulting with a financial advisor or tax professional on the benefits of a 1031 exchange, which allows you to defer capital gains earned on rental properties.

Marry the Property, Date the Rate

What goes up, will go down. And in the case of interest rates, it will also go up again. Rising interest rates are nothing to fear, they are something to expect. And although it’s impossible to predict the future, one can assume they will eventually drop again at some point. If they continue rising and never come back down, you’ll appreciate that you have a locked-in, 30-year interest rate now. If they do drop to a lower rate, you can always refinance your loan at a lower rate when the time feels right to you.

If you are considering investing in a rental property and have questions or concerns about interest rates, market values, or property management, give us a call or contact us at Rooftop Real Estate Management.