2 Types Of Real Estate Investments That Are Especially Profitable During Rising Interest Rates

Since the 2008 recession, the U.S. has experienced record low interest rates. Currently, the Federal Reserve (Fed) is raising interest rates to combat inflation. These rising rates impact all sectors of the U.S. economy, especially real estate.

Markets have been declining recently, and many investors are pessimistic. However, unique opportunities that could include higher yields and undervalued commercial and residential real estate investments are emerging.

Higher Rents

Rising interest rates can be especially profitable for real estate investors as rents increase during this time. Per a Forbes study, real estate investment trusts (REITs) outperformed the overall market in a rising rate environment from June 2004 to August 2006. REITs returned 60% compared to the S&P 500’s return of 20% during this time.

Rising rates hold a silver lining: a recovering economy. The pandemic is ending, and life is returning to normal. Unemployment is at record lows, and wages increased by 4.5% in 2021. A recovering economy is one of the reasons behind higher rents.

Undervalued Residential and Commercial Real Estate Investments

As rates rise, so does the cost of financing property via a mortgage. Higher mortgage rates reduce demand for residential homes, which in turn lowers prices. As prices decrease, red hot housing markets may experience a correction.

Many markets are seeing increasingly high demand, resulting in bidding wars and homes being sold over asking price. A correction would make it easier to buy quality properties at a discount. Real estate investors scooped up many deals after the 2008 crash as real estate prices recovered 83% in the 10 years after.

Commercial Real Estate Yields

Higher rates can also result in higher capitalization or “cap” rates. A cap rate takes the net operating income of the property (NOI) and divides it by the property’s value. A higher cap rate means that the investment is higher risk and potentially higher reward.

Some main components of the cap rate are rents and property values. Increasing rents result in a higher NOI. Like residential real estate, commercial real estate valuations generally decrease with higher rates since borrowing costs increase, allowing investment in commercial and residential real estate at substantial discounts.

2 Profitable Investments During Rising Rates

Rising rates can be beneficial for many real estate investments. However, the best real estate investments during this time are those that have high demand and use low, fixed-rate financing.

Extra Space Storage EXR

Utah-based REIT Extra Space Storage EXR acquired $6.19 billion of its $6.26 billion debt prior to 2022, meaning that most of it was financed at low rates.

Combined with increasing rents, Extra Space Storage is especially profitable with a healthy net profit margin of 49.76%. Unlike other REITs, this company isn’t over extended since its debt is approximately 60% of its total assets.

This REIT is in a unique sub-niche: self-storage.  Because of remote work, the pandemic and other factors, the demand for self-storage has soared. In fact, it’s predicted that this industry’s revenue is expected to grow to $49.24 billion in 2024 up from $37.33 billion in 2018.

Extra Space Storage is riding this trend and has a 96% occupancy rate. It has also benefited from higher rates that increased 22.3% year over year to $21.00 per occupied square foot. Higher rents and locked-in, low-rate financing make this REIT a potentially good play during this time.

Yieldstreet Income Investments

Yieldstreet is a crowdfunding platform that lets accredited and non-accredited investors access alternative asset classes like commercial real estate, art and consumer loans.

Yieldstreet Prism Fund: One Yieldstreet opportunity that could be profitable during this time is the Yieldstreet Prism Fund. The Prism Fund focuses on income payments and has a healthy distribution rate of 8%. It invests in numerous areas, including art, consumer loans and commercial and residential real estate loans.

It currently has $98 million under management, and investors can buy in for as little as $500. One of its top holdings is consumer loans like title and cash advance loans. Increasing interest rates result in higher cash flows in this sector.

Investors can access a well-diversified portfolio of income-producing investments that do well during rising rates for a low minimum. 

Growth & Income REIT: Aside from the Prism Fund, Yieldstreet has other income-producing investments like its non-traded Growth and Income REIT. This REIT invests in sub-niches like multi-family, industrial, office, single-family rentals and storage. It primarily focuses on equity real estate investments but has exposure to debt real estate investments like mortgages.

Bottom Line

Over the last 15 years, the U.S. economy has had record low interest rates, which started as a response to the 2008 recession. Fast forward to present day, the Fed is starting to raise interest rates at higher frequencies.

While markets have been declining, investors can find many unique opportunities in this environment, especially in real estate. Rising rates can provide investors higher yields and the opportunity to buy commercial and residential real estate at a discount.

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