In this video, I'm going to talk to you about why
I believe that rising interest rates are going to create a tsunami of problems
for many real estate investors. And a lot of people
that are invested in a lot of projects. So for all of you naysayers
who think this is just click bait, argue with the facts, there's five, five,
count them five. Interest rate increases
from March of this year. And here they are right here in order. So you can see
you cannot argue with the fact. So the result of this is that people
can't afford housing and their mortgage payments have gone up
over $1,000 a month in many cases. What's not being talked about
much are the people that are buying investment properties
and how these rates are affecting them. And that's what this video
is going to go into next. Before we go into the next slide,
I want you to know that we're not quite done. There's two more rate increases. And if inflation doesn't come down
by the end of the year, they'll be more in 2023. Now, in a period of just a few minutes,
I found all these articles showing how interest rates are impacting people
and they're impacting everyday people for student loans, credit cards, auto
loans, mortgages, all that kind of stuff. It's everywhere. And of course, if you guys aren't looking at this stuff,
then of course your head is in the sand. But these big rate increases
are causing problems for many people, not just real estate investors. What I want you to pay attention the most
is this one here where it says the Federal Reserve's increasing interest
rate hikes have put Main Street. That's not Wall Street.
That's Main Street. That means everyone, the economy, dangerously
close to the edge of a lending cliff. And this is what we're going to talk about
today is debt. What this is doing to people's debt,
specifically with real estate investors. In the past few years, most of the real estate investors
have put out deals that said, hey, we're going to buy this project,
we're going to increase the income and we're going to reduce the expenses,
and we're going to grow the net operating income
and all is going to be fine. And oh, by the way,
we're going to put a loan on it and then we're going to cash out,
refi or sell later and we're going to make all this money. And that's how most deals are pitched. And while everyone was busy
focusing up here, this is actually the problem at the moment
is the interest rates have gone up and the cost of debt has gone up
or many real estate investors. This is going to be the death of them. Now we're going to look at three
components of debt. One is the type. So that would be a fixed
or say, a variable rate. The second would be the rate has have
rates been at 4% or 6% or 5% or 3%. And the third one is the term. Is it monthly? Is it one year, two years,
three years or longer? So those are very important things
we're going to talk about next. And depending on the type of debt
or terms that you've negotiated for, your particular deal is going to vary
widely on how that deal performs next. So now let's take a look at just a $1
million deal that somebody might buy. So now we're just going to focus
on the debt piece, of course, and we're just going to assume
that everything's fine on the income and the expenses and
you might even have a value add going on. But the debt is
what we're going to discuss here, and that could wipe away all your value. Add that you get a lot of the deals
that you might have invested in are going to focus on the income
and expense side. In other words, they're going to say, hey, we can buy this property
and it's a value add. And value adds are largely going to have
adjustable rate mortgages because what you want to do
is you want to capture that value and then put a fixed rate
loan on it later. So in other words,
you don't want to put a fixed rate loan on it now because you might have
a big prepayment penalty later. So you put these bridge
loans or variable rate loans on while you're doing all the work,
you're growing the value. And the idea was to do a cash out
refinance using more debt. That's the model that a lot of deals were done doing
and a lot of people invested in. So the problem, of course, is that
debt has gone up. So in this scenario,
I just use $1,000 investment, but the $200,000 down payment
at a 4% rate, as you could see, the actual mortgage
payment is about 3800 bucks. And as the rates went from 4 to 6,
as you can see in this scenario, that means that the actual payment
has gone up $1,000 a month or $12,000 a year. And why that's important is
because these rates have only gone up 2%. The same mortgage, the same loan amount. So what that is going to do to cash flow,
it could put a lot of these deals into a negative cash flow situation. So that's just on a deal of $1,000,000. So now let's look at a $10 million
acquisition with a 20% down at a 4% rate, which, by the way,
could have just been a year ago. At the time, the monthly payment
would be right around $38,000. And as you can see from just six months
in five rate increases, rates have gone up to around 6%, putting
the mortgage payment of around $48,000. So, again, $10,000
a month or $120,000 a year. My guess is a lot of this is going to wipe out the cash flow,
even puts you in a negative situation. All things being equal here, maybe you've grown the income,
maybe you've reduced the expenses. So maybe you've captured
this increase of debt, but maybe not. And that is actually what I think a lot of
people are unprepared for right now. So the question is who's going to be most at risk
and who potentially could go broke, losing all of their money? And I broke it down to four things. One, adjustable rate.
We talked about that. So if you had a 4% rate, let's
say one year ago and now they're six, that means your mortgage payment
has gone up each and every month and your cash flow has gone down
each and every month. The second one would be
if your terms are expiring. So that would be a loan maturity
or something that was rather short term. And of course, again,
it's adjusting to the new rate because you're entering into a new term
and you're at risk because your debt costs will go up
and your cash flow will go down. The third one would be on rate caps. So when you're getting a loan, you can buy an actual rate cap,
you can hedge it like an insurance policy. And this is what we did on all of our
short term debt, our three year debt. We put rate caps on our
SO we have rate caps through the middle of 2024
on a lot of our deals. So we're hedging our rates at the time. My partner and I, Ross,
because we were experienced, we said we better put these on
just in the event that rates are increasing
and a lot of investors did not do this. So many investors, monthly debt costs are
going up so fast, much higher than rates. And the lowering of expenses are
and their cash flow is getting eaten away and might even be negative. The fourth one is going to be around
cash reserves. Now, most prudent, experienced investors
are going to have lots of cash reserve. You guys all know that Ross and I
went to six months of cash reserves when the pandemic hit. We're right. We're at three now. We're at six. And now lenders are starting to do 50% loan to value
and they're making the syndicators and the GP's or general partners
put up even more cash for loan reserves. This is a very important thing
and this potentially is something that you can ask as a limited partner
or as a general partner. You need to make sure that you're
putting lots of cash reserves down because the last thing you want to be
doing is having more interest rate risk. Because remember, we have another Fed meeting in November
and then another one in December. And so these rates could go up even higher
and your cash flow could go even lower. So you need to make sure
that you're managing these debt costs, especially if you're handling
other people's money. This is a very important thing,
and so is this. And you need to be very transparent
on what's happening. We already have some of our more sophisticated investors
asking me this very question. Did you guys buy rate caps? Where are your rates?
What's your cash flow look like? Are your projections consistent with what you said they were
going to be in the business plans? These are all things that a limited
partner should be ask, could be asking and will be asking. If you're not prepared for this,
you better be careful because you might be facing not being able
to refinance or even sell these deals if you run out of money and people
are going to be coming after them later at deep discounts. The last thing you want to do here is wait,
because the Fed is battling high inflation and it looks to me
like we're going to have continued rate increases into the future,
which is going to drive many of these deals
into more and more negative cash flow. And you're going to be faced
with a cash call or have to force a sale or you won't be able to cash out, refine
your investors are going to be very, very, very unhappy.
