The competition for homes has been Tiger King crazy intense these past few years. With fewer existing homes on the market to sell and fewer new units available for sale (in part COVID shut-downs and due to material shortages), homeowners and investors like me have been forced to expand budgets and get creative with purchase offers. Beyond offering more than the asking price, a free rent back to the sellers, or waiving the home inspection, some buyers have been throwing in more unique items to try to make their offers stand out, such as naming rights to a first-born child or a free beach vacation (see More than a Mortgage: The Weirdest Buyer Offers).
Fortunately for buyers, it seems that things are slowing a bit. According to the discount brokerage firm Redfin, 73.1% of homes they sold in April 2021 faced a bidding war. However, in April 2022, that rate dropped to 60.7% — an indication that the housing market is starting to cool off. This is great news. The whole bidding-war business makes my stomach hurt with flashbacks to teen dances and picking teams for PE. Fortunately, this slowing of the market should help buyers and sellers complete their due diligence and avoid rash (sometimes expensive) decisions.
The main reason that sales are slowing is rising interest rates for mortgages (see Homebuyer Competition Falls for Second-Straight Month, Hitting Lowest Level in Over a Year). To combat inflation, the U.S. Federal Reserve has been inching up interest rates in the past few months. Although 2022’s interest rates of 5% may seem high after nearly eight years when mortgage rates hovered between 2% and 4%, they’re still very low historically compared to 1981 and 1982 when the average mortgage rate hit 16% (see Mortgage Rate Trends Over Time). That said, these rising rates ultimately make home ownership more expensive because homeowners are required to pay more every month toward their mortgage to pay for a less expensive house than they could afford a year ago.
How exactly? Using an example from Investopedia, if a homebuyer gets a 4% rate on a 30-year-fixed mortgage for a home worth $400,000, their monthly mortgage payment would be $1,900. But if the buyer can only get a 5% interest rate, their monthly payment rises to $2,138. That increase of 1% raises their payment by 13% or about $240 a month. Now instead of buying a $400,000 house, the buyer can only afford to purchase a home worth $355,000 and stay within the same monthly payment.
So what does that mean for investors — have you finally timed the market right? Maybe? The good news is that there does seem to be a little less frenzy in some areas and some deals are starting to appear again. That said, as a real estate investor, I try not to focus on timing the market but instead focus on the fundamentals of each deal and understand the risk that comes with it. (I did say try. It’s hard not to get tempted after years of not seeing any deals at all!) To stay focused, we like to stick to our basic formula when it comes to investing in rental homes. Our hope is that following our investing criteria will help us follow the fundamentals to find properties that work for our business model rather than jumping too fast. My quick rule of thumb is I want get about 1% of the home’s purchase price plus initial renovations in rent every month. If the property doesn’t give me enough upside, I move on to others that do.
My other philosophy is focusing on the long-term investment strategy. I don’t want to flip homes, I want to own homes, rent them, and renovate them over time to make them more valuable. Warren Buffett has said he doesn’t buy stocks because he thinks their prices will rise this week, this month or even this year. For the most part, Buffett says he purchases investments with a “forever” mentality (see Warren Buffett’s Investment Strategy). I highly doubt I’ll ever reach Buffett’s level of investment success, but I hope to at least insulate ourselves with good investment strategies to avoid the anxiety of market timing.
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