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In September, the Federal Reserve cut interest rates by a quarter point, the first in 2025. They also signalled that they expect two more rate cuts this year.
Does that make now a good time to invest in real estate?
I don’t believe in timing the market, and I continually invest $5,000 a month in new real estate investments.
Market timing aside, there are both risks and opportunities for real estate investors during rate-cutting cycles. Keep your eye on both as you explore investing in real estate over the next year, whether as an active buyer or passive investor (like me).
Opportunity: Cheaper Debt
The Federal Reserve doesn’t control mortgage rates. It controls the federal funds rate, the short-term interest rate that banks use to lend each other money.
Mortgage and commercial loan rates are based on Treasury bond yields, which the Fed doesn’t control. In fact, mortgage rates ticked up when the Fed raised the federal funds rate.
Even so, loan rates have historically shared a strong correlation with the federal funds rate. Most analysts expect lower mortgage rates over the next year, making refinances and purchase debt more affordable each month.
Opportunity: Better Cash Flow
All else being equal, cheaper debt means investment properties will cash flow better. They’ll generate a higher cash-on-cash return or yield.
Of course, lower loan rates typically drive up property prices as well.
Opportunity: Potentially Higher Property Values
When mortgage rates fall, buyers can afford to make higher bids for homes, because most homebuyers calculate their maximum purchase price based on the monthly payment.
So they do make higher offers, which of course drives up home prices. Read more from the Federal Reserve about that trend if you’re curious.
The same holds true for commercial real estate such as multifamily properties. Loan rates and cap rates tend to move in lockstep. Lower interest rates drive down cap rates, which means higher property values.
That’s great for current owners, who can get some relief by refinancing or selling at a profit instead of a loss.
Opportunity: Distressed Sellers
The Federal Reserve doesn’t cut rates without a good reason. They do it to help juice the economy when it starts sagging.
A weaker economy often means more loan defaults from distressed sellers. That creates buying opportunities for both residential and commercial investors.
In our co-investing club, we just invested in a passive real estate deal, buying a distressed property. The seller was in foreclosure, so the operator was able to buy the property at a deep discount.
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Risk: Higher Unemployment Means Higher Vacancies
Specifically, the Fed cuts rates to spur a lagging labor market, meaning higher unemployment.
Higher unemployment means more rent defaults, both among residential and commercial tenants. More rent defaults mean more evictions and higher vacancy rates, which in turn mean weaker cash flow.
In many cases, “weaker” becomes negative cash flow. Investors can find themselves losing money each month on investments and become distressed sellers themselves.
Risk: Lower Cap Rates for Buyers
That potential for higher property values that I mentioned earlier? That’s great for sellers, but not so great for buyers.
Buyers might find themselves paying more for the same cash flow, otherwise known as compressing cap rates.
Risk: Price Volatility
Again, the Fed cuts interest rates when they’re worried about a weakening economy and recession risk. And in deep recessions, buyers pull back, which depresses prices.
However, property prices don’t always go up in rate-cutting cycles. Home prices fell 25% to 30% on average in the Great Recession.
Even so, recessions don’t always drive down prices. In four of the last six recessions, home prices actually rose—not least because lower interest rates stimulate price growth. It’s not always clear which direction property prices will move, however, hence the risk of volatility.
Risk: Overheating and Bubbles
Some Americans have openly questioned why the Federal Reserve should remain independent of political interference. Why? To them, I would say, “So that politicians can’t overheat the economy while they’re in office and leave a ticking time bomb for the next administration.”
Every president wants a glowing economy under their watch. But recessions are part of market economics, and the longer you artificially delay one, the worse it will be when it eventually hits.
One form that overheating takes is too much debt accumulating in the economy. Businesses and consumers alike become overleveraged, and the longer these debts are allowed to build up, the more pressure builds in the system that eventually bursts, often in the form of an asset bubble or recession.
Low interest rates incentivize debt. That can help when the economy is slow, but it can overheat the economy if left unchecked.
I don’t trust politicians worried about the next election to make these decisions, and you shouldn’t either.
Risk: Inflation
Cheap loans are why the Fed raises interest rates to fight inflation.
Inflation isn’t all bad for real estate investors, of course. Buyers simply pay the going rate for properties; however, the currency fluctuates. Inflation can push prices up faster than expected.
But inflation also causes the Fed to raise interest rates, which can wreak havoc for real estate investors. It’s why multifamily properties fell 20% to 30% in value after the rate hikes of 2022, which has created an opportunity for buyers, but a nightmare for sellers.
Investing Through Rate Changes
How far will the Fed cut the federal funds rate? Will Treasury yields and loan rates follow suit?
Investors can only speculate. And I don’t invest based on speculation. Instead, I practice dollar-cost averaging with both my real estate and stock investments. Investing $5,000 each month alongside other passive investors in a co-investing club, rain or shine.
That keeps me investing even when other investors panic from the “blood in the streets.” It also limits my exposure to any one investment.
On balance, I see more opportunity than risk right now for real estate investors. I see hands-off real estate investments as undervalued at the moment, especially compared to an overpriced stock market that seems to notch a new record every week.
Only you know how to best invest for your own financial goals. Just know that the riskiest thing you can do is not to invest at all, because you’re guaranteed losses from inflation.
