What Can Happen to Rental Properties in an Inflationary Period?

The owners of multi-family income properties have enjoyed a period of calm since the last major change in accounting practices took away much of their tax advantages. But looming on the financial horizon is the coming inflation that we will be facing because of current governmental deficit spending.

I think the biggest shocker for many investors who accumulated 10, 20 or 50 or more rental units is what happens when they go to sell. Bulk sales seldom go smoothly as buyers see an opportunity to take advantage of a motivated seller. This is especially true if there is a probate involved and estate taxes are due. But careful financial planning can alleviate much of these problems. The best alternative, if it is still available, is to sell in bulk to hedge funds if they still have ravenous appetites for income producing properties.

What can’t be planned into the equation is what interest rates will be when the properties have to be sold. Interest rates fluctuate “inversely” to the value of the asset. Most common in the financial markets is the daily action of Treasury bonds that trade in the trillions of dollars. As interest rates go up slightly, the principal value of the bond declines and vice versa.

The standard in the industry for calculating yield is the CAP or Capitalization Rate. This number is the Yearly Income/Total Value (or Cost Basis) and expressed as a percentage.

If you purchase a property for $100,000 that has a 7% CAP and interest rates drop to 6% your property will be worth $116,600. However, if for the same property, the interest rate rises to 8% CAP, your property will be worth only $87,500. Interest rates have historically risen as high as 14% on FHA mortgages and 18% in CD’s in banks. If we get back to 9% CAP rates on rental income properties, your $100,000 property could be worth as little as $72,000! Your choices are take a loss, be a landlord forever or find an unsuspecting new investor who is enthralled with “passive Income” and tax benefits.

What does all that mean? Simply put, if you are contemplating buying rental properties you should not be willing to accept a yield of less than a 9% to 10% CAP rate. If you already own rental properties, this may be the best possible time to start reducing your inventory by selling to hedge funds or other investors.

One problem that very wealthy people have is finding an investment that is both somewhat safe and gives an income. Traditionally, larger commercial apartment buildings and commercial properties have filled this need. Typically these properties trade in a somewhat narrow range of 6% to 8% CAP rates until the seller needs to sell and then he is fair game for “scavengers” to get the property.

When it comes time to sell these properties, what saves many of these landlords is doing Seller Financing. This technique allows a buyer to come in and bring much less money to the closing table. Historically, many of the loans on these properties are also transferrable without the buyer qualifying for the loan. I mention this because we recently asked for owner financing on a large apartment complex. The seller said he would give 60% of the purchase price with four points at closing and 15% interest.

I asked him the most important question an investor could ask a seller, “Why are you selling?” and he answered, “We want out of fixed income investments!”

Likely the hedge fund that we are attempting to sell this property to will eventually package it into a Real Estate Investment Trust (REIT) and sell it to the unsuspecting public at a yield (CAP) that slightly exceeds Certificate of Deposit (CD) rates at the time of the offering. The hedge fund will make millions of dollars and the public will essentially be holding a “bond” portfolio that will be liquidated in the years to come, most likely at a loss. How do I know, because it has been done many times in the past – same old, same old. Wall Street wins every time over the trusting public.

In summary, if you intend to accumulate passive income through rental income properties, don’t accept CAP rates of less than 10% to give you some insulation from future swings in the interest rate market.

To your limitless success

Dave Dinkel has over 40 years experience in Real Estate Investing which has given him a unique perspective into the Market. Learn the proven methods of today’s successful Real Estate Investors. Visit Dave Dinkel’s site to get you started as a Real Estate Investor today! Click the link Now http://www.davedinkel.com