Interest Rates vs. Rent Growth

Lately I’ve been fielding questions from our investors about interest rates and their effect on investment real estate.  Rent growth has been the answer.  I’ll cover that next.

My name is Kenny Wolfe and I’ve been a real estate syndicator and investor for over eleven years; in this time, I’ve built a successful real estate investment firm, Wolfe Investments. If you’re new to the show, make sure to subscribe so you’re notified when a new episode comes out. 

Website: https://www.wolfe-investments.com

Email: investors@wolfe-re.com

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Transcript

Kenny Wolfe (00:00):

Lately I've been fielding questions from our investors about interest rates and their effect on investment real estate. Rent growth has been the answer. I'll cover that next. Welcome to Real Estate Investing with Kenny Wolfe, the show with weekly topics designed to help you learn how to build your ideal life through real estate investing. My name's Kenny Wolfe and I've been a real estate syndicator and investor for over 11 years now. And in this time I've built a successful real estate investment firm, Wolfe Investments. If you're new to the show, make sure to subscribe so you're notified when a new episode comes out. Do you guys remember the great rates we used to get in early 2022? Not only that, but we were getting amazing loan terms from bridge lenders. We had floating rates but could buy an interest rate cap for cheap. Leverage was high and amortizations were easily at the 30 year mark, and all of those were non-recourse loans times were good.

(00:45):

If you didn't go to the bridge lenders, then you are most likely going to the agency folks. So that's Fanny May, Freddie Mac or hud. They too were handing out non-recourse loans with low fixed interest rates. Great 80% leverage and 30 year and sometimes more amortization. We here at Wolfe Investments we're not using much local or regional bank loans. Their terms weren't near as good and they tended to be recourse loans back in February of 2022, that all started to change. Do you guys remember transitory inflation? Where do they come up with these phrases? Inflation is usually not a quick fix, and for those that understand basic economics, you could quickly see through that transitory inflation phrase. So what caused this massive inflation? It was a combination of a few things, but one main driver. There was way too much money pumped into the economy while the world was getting over covid.

(01:31):

All that money injected into the economy this time was sent to individuals. By the end of June of 2022, here in the states, we had almost 5 trillion of demand deposits. That's money in people's checking and savings accounts. In comparison, in November of 2019, we only had 1.6 trillion of demand deposits. That means cash in individuals checking and savings accounts. There was a huge growth of about three times of what it was compared to pre covid time period. When you throw that much cash into an economy, of course that currency of value will go down and thus spark inflation and you can see the effects of all that cash sitting in folks bank accounts right now. I know when we traveled this summer as a family and every business trip I took out of Dallas Fort Worth airport, you could barely find a parking spot. That meant people were spending money on travel and everything else.

(02:19):

But beyond travel expenditure, everything else has jumped up in price as well as we all know. I do think part of that initial inflation was caused by supply chain issues of the economy, finally getting back to work. But we're well past the point of blaming supply chain now for this inflation. It's now just too much cash in the system and in our real estate portfolio. There is still rental assistance being dolled out in some of our markets, which is crazy and they wonder why we still have inflation. So the Federal Reserve started to increase the federal funds rate to tamp down this inflation, but they really can't raise interest rates enough to get inflation back down to their two to 3% a year target. There's just too much cash in the system. And just the other day, the United Nations asked the Fed to stop the interest rate hikes as the rest of the world is starting to feel the pain.

(03:04):

On top of that, our national debt is an ever-growing higher amount, and that means the interest rates will have to come back down quickly. I think rates start to come back down in June or September of next year. Goldman Sachs thinks it's January of 2024. We'll see who's right. The only way for this inflation to stop are two things. The government has to stop pumping massive amounts of money into the system, and two, this cash already in the system has to work its way through the process. Inflation has the hardest impact on the lower demographics in an economy. Staples like food, gasoline, clothing, et cetera, make up a bigger percentage of what folks take home. Pay the lower down the totem pole. You go on the median income levels. Inflation also has large impacts on entire industries as everything costs more to produce. Since we're in the real estate business here at Wolfe Investments, I'll give an example around developing new multi-family properties.

(03:52):

The cost of labor and materials really jumped up these past few years. So it's costing developers like us a lot more money to build housing where it is needed. Lumber is the material that stole the show the past year or so and grabbed all the headlines. But you can see how between supply chain and the inflation already going on in the system that costs shot through the roof to develop these assets. At one point here at Wolfe Investments, we were talking about using light gauge steel for framing from our firm, framing material instead of wood. So when steel starts to look like a better option than wood, there's definitely something really out of whack in the economy. And there wasn't a shortage of pine trees in East Texas, I can tell you that. So all these increased costs of labor and material forced our completion costs to jump up.

(04:31):

So instead of building a new multi-family apartment unit for 150 k a door here in Texas and about 180 k a door, there in Ohio. The new completion costs are in the 200 K to 250 k a door range depending on your finish out, your location, et cetera. So in short, the cost to complete a new finish unit is jumped in a big way. Because of this higher cost, you have to get higher rents to make the numbers work from the investment side. It also means that you can't build B or C class housing units. You have to get a class rents to make the numbers work at these completion levels. Now inflation is really what saved the real estate investing community as well. A big part of what makes up inflation is housing. It's a basic requirement and that's why I like this asset class.

(05:12):

Everyone needs shelter and has to live somewhere. That means there will always be demand for the units we provide. Rental rates shot up across the board in the United States and, specifically in our portfolio, we saw double digit renewal increases and residents continued to want our upgrade unit interiors and were willing to pay that rental premium for those better finish outs. That demand continued to push rents up and up. I personally don't see a slowdown in rental growth for a very long while. Between all the cash in the system and the massive housing shortage we have in our country today, we'll have rental growth for the long haul. That's why here at Wolfe Investments, we are continuing to buy existing multi-family assets today and taking on new development projects. It's these rental bumps that have outpaced any pain we've felt from the interest rate hikes. Yes, inflation is real and here to stay until the cash and demand deposits slows its growth. Rates have been bumped up, but will have to come back down here soon. So stay of the course, keep calm and invest on This has been real estate investing with Kenny Wolfe. Thanks so much for listening.