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Here’s How I’m Protecting My Investments From What Could Go Wrong Next Year
As 2025 approaches, many investors are wondering about the state of inflation and interest rates. Has the Federal Reserve conquered inflation? Will interest rates continue their upward trend, or will we see relief?
While I don’t have all the answers, and you should be cautious of anyone who claims to know what’s coming next, I’m still confident in my real estate investments. Here’s how I’m positioning my portfolio to protect against the potential risks posed by inflation and high interest rates as we move into the next year.
Investment Mix: Equity and High-Interest Debt
Inflation is a major risk for fixed-income investments, such as bonds. In 2022, inflation hit 9.1%, while some Treasury bonds paid just 2%, resulting in a loss of 7.1% for bondholders—or worse, selling them at a steep discount.
On the other hand, equity investments, particularly in real estate and stocks, have historically held their value during inflationary periods. Businesses can raise prices in line with inflation, and property owners can increase rents.
I focus on a mix of equity investments in real estate and stocks, with some high-interest debt investments secured by real property. While inflation might eat into the interest returns on debt investments, equity investments still tend to provide a hedge.
Long-Term, Fixed-Interest Financing
Over the past few years, our Co-Investing Club has been cautious about using short-term bridge debt or floating interest rates. The future of interest rates is uncertain, and if inflation spikes again, high rates could persist longer than expected.
When we evaluate new passive real estate investments, we seek properties with protection against high rates—such as fixed-interest financing, rate caps, or swaps. Additionally, we look for loans with plenty of time before maturity, so operators have time to sell or refinance when market conditions are favorable.
Strong Cash Flow
While there’s no right or wrong way to invest—cash flow vs. appreciation—it’s cash flow that I prioritize. Investments with strong cash flow can weather buyer’s markets, allowing you to sit back and enjoy distributions while waiting for better market conditions.
For example, a recent deal vetted by our club provides an 8.6% cash flow in its first year, rising to 12.7% once stabilized. Investments with weak cash flow, on the other hand, can quickly turn into financial burdens if market conditions don’t go in your favor.
Investments That Don’t Rely on Interest Rates
A recent cash-flowing investment vetted by our Co-Investing Club doesn’t depend on interest rates for success. While interest rate cuts could certainly help, the investment is set up to deliver strong cash flow regardless of whether rates go up or down. Our strategy is to refinance in 3-5 years to return 100% of our capital, but even if interest rates remain high, the investment will continue to provide solid returns.
Additionally, we’ve invested in a land-flipping fund that doesn’t require low rates to thrive. It flips parcels every 4.1 months and has earned returns in the low 30s since inception. These investments, like house flips and spec home projects, will do fine even in a high-interest-rate environment.
Opportunistic Distressed Deals
While downside risk protection is a key focus, we also see opportunities to acquire valuable properties at a discount. For example, we recently purchased a property at a significant discount from a hedge fund that was in trouble due to floating-rate debt.
This deal is already paying an 8% distribution, expected to rise to 9.5%, with an anticipated annual return of over 20%. Even if interest rates stay high, the operator can hold onto the property longer to wait for a better selling market, ensuring the investment’s continued success.
Diversification
Diversification is a cornerstone of my investment strategy. I don’t try to time the market or pick the next hot property type or asset class. Instead, I invest passively in various property types across the U.S., practicing dollar-cost averaging by investing $5,000 each month through SparkRental’s Co-Investing Club.
The market is complex and unpredictable, so spreading my investments across different timelines, markets, property types, and operators helps ensure that I’m still standing when the next downturn comes—while others might struggle.
Don’t Be Clever—Think of the Long Term
Diversification might not be flashy or impressive at cocktail parties, but it’s the most reliable strategy to protect against market shifts. By investing across a range of markets, timelines, and asset classes, I’ll keep growing my portfolio and remain in the game, even if some investments hit a rough patch.
While there may be occasional setbacks, I’m confident that my diversified approach will continue to support my long-term financial growth, even when others are scrambling to recover from unexpected changes.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“
Here’s How I’m Protecting My Investments From What Could Go Wrong Next Year
Has the U.S. Housing Market Finally Begun to Thaw After the Pandemic?
It seems like the housing market might be showing signs of life. According to a recent report from Redfin, pending home sales in early October have seen their largest year-over-year rise since 2021, with a 2% increase in the four weeks ending October 6.
This news is likely to be welcomed by real estate investors who have felt the market has offered limited opportunities over the past few years. However, it’s important to take a cautious approach—one promising statistic doesn’t necessarily indicate a broader trend.
Is the Housing Market Truly Recovering?
Let’s explore the different factors at play.
Interest Rate Reductions: A Critical Factor or a Red Herring?
The Redfin report links the surge in pending sales to the Federal Reserve’s much-anticipated rate cut announcement in mid-September. According to Redfin, this announcement prompted buyers to re-enter the market in late September, despite mortgage rates having already been falling for weeks before the cut.
This psychological boost is crucial. Although buyers were aware of the falling rates beforehand, many seemed to be waiting for a formal signal to act. This could be attributed to a lingering fixation on the ultra-low rates of 3% to 4% that buyers enjoyed before 2022.
Any rate cut announcement serves as a nudge for prospective buyers, making them feel that now might be the right time to purchase, even if mortgage rates had been decreasing already. In an unstable mortgage market, such announcements hold significant influence.
However, mortgage rates are just one piece of the puzzle when analyzing housing market performance. As noted by Investopedia, the real estate market is driven by four primary factors: interest rates, demographics, economic conditions, and government policies.
Demographics: Shaping the Market
During the pandemic, demographic shifts had a profound effect on U.S. real estate, with major population movements like the Sunbelt migration fueling booms in cities such as Phoenix and Austin, which later became unaffordable for many.
Age is another key demographic factor, and the millennial generation’s pent-up demand continues to be a driving force behind the rise in home purchases. Despite the challenges of the past few years, millennials who have longed to become homeowners are now entering the market in greater numbers, as more properties become available.
Rising Inventory: A Sign of Stabilization
A key factor contributing to the market’s stabilization is the growth of housing inventory over the last year. The pandemic had a significant impact on the availability of homes, with sellers hesitant to list properties due to COVID-19 restrictions and, later, higher mortgage rates.
Some homeowners, particularly those upgrading to larger homes, found it financially challenging to sell and take on higher mortgages. Others, however, simply chose to wait for a more favorable market.
Although the latest Realtor.com report shows that inventory remains down by 23.2% compared to pre-pandemic levels, we are seeing an upward trend. For instance, new listings have been rising since last year, with a 5.7% year-over-year increase for the four weeks ending October 6.
As of September 2024, some states have even surpassed their pre-pandemic inventory levels, including Tennessee, Texas, and Idaho, with others, like Washington, close behind.
Vulnerabilities in Certain Regions
However, not all regions are showing positive signs. For example, some areas, particularly those affected by extreme weather, have seen inventory spikes not because of market recovery, but due to homeowners trying to offload damaged properties they can’t afford to repair.
For instance, regions like Florida and North Carolina, hit by hurricanes, have experienced increases in home listings, but these may reflect a response to climate-related challenges rather than market health.
Opportunities for Investors
Investors should be discerning when choosing markets, focusing on regions where inventory is growing due to increased home construction rather than climate-related distress. States like Idaho, Utah, North Carolina, and Texas, which are building new homes, offer potential, though caution is needed in areas prone to natural disasters.
The Midwest and Northeast, meanwhile, still face significant challenges in recovering to normal market conditions. These regions have lower rates of new construction, meaning inventory remains scarce, which could present both opportunities and difficulties for investors.
The Bottom Line
The U.S. housing market is showing signs of recovery, but the situation remains complex and varies by region. Interest rates play an essential role in unlocking the market, but investors should also consider other critical factors, such as homebuilding trends, climate risks, and government policies. While the market is heading in the right direction, it’s crucial to examine regional differences carefully before making investment decisions.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“