The gravity of real estate
Interest rates are the gravity of real estate: they influence financing costs, the price a buyer will pay, and the yield an investor demands. It is tempting to build a strategy around a view of where rates go next. We try not to. Even the Federal Reserve publishes its own rate projections and then revises them as the data changes,1 which is a useful reminder that a forecast is an input, not a plan.
Show the work — sources
Figures attributed to third parties are as of the dates shown and were not independently verified by Freedom Funds.
Forecasts are fragile; structure is durable
Our approach is to underwrite so that a deal works across a range of rate outcomes, rather than requiring one. Concretely, that means a few habits. We favor moderate leverage, because debt magnifies losses precisely when markets are least forgiving. We prefer fixed-rate or rate-protected financing so a spike in short-term rates does not quietly eat the distributions. And we assume exit capitalization rates at or above where we bought, rather than betting that a future buyer will pay more simply because rates fell.
1 of 6 — Fixed-rate or rate-protected financing.
Six practices and assumptions from this article, one at a time. Call each one: does it need the forecast to be right, or does it work either way? No stakes. Almost no stakes.
Refinancing risk is the one to respect
The place rate moves do the most damage is refinancing. A business plan that depends on refinancing at a favorable rate on a specific date is really a rate bet in disguise. We try to stagger maturities, keep conservative loan-to-value levels, and preserve reserves so that we are not forced to transact into a bad market. If rates cooperate, that is upside; if they do not, we want to be able to wait.
Margin of safety, not market timing
All of this is a long way of saying we would rather buy at a sensible basis with durable cash flow than time the cycle. A margin of safety — a discount to replacement cost, in-place income, conservative debt — is what lets an investment absorb the surprises that a forecast cannot anticipate. It is less exciting than a bold rate call, and in our experience it survives contact with reality more often.
To be clear, this is philosophy, not prophecy. Rates, cap rates, and financing availability can move against us; forward-looking statements are inherently uncertain and may prove wrong; and nothing here is a prediction or a promise of results. It is simply how we try to make decisions when the one thing we can be sure of is that the forecast will change.
Sources
- Federal Reserve, Federal Open Market Committee "Summary of Economic Projections" (illustrates that official rate projections are revised over time). https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
