How high interest rates can increase real estate returns

In real estate, interest rates play a significant role in shaping investment strategies. While conventional wisdom suggests that higher interest rates negatively impact investments, real estate investors can actually benefit from higher interest rates when banks are paying higher rates on cash deposits.

The power of cash savings

One of the advantages of higher interest rates is the increased earning potential of cash savings. As a real estate investor, you likely maintain substantial cash reserves for various purposes like down payments, renovations and any unexpected expenses. When interest rates are low, the returns on cash deposits are minimal. During periods of high interest, however, you are rewarded by banks for having more cash deposited. This means you could use these savings to increase your earning potential.

Leveraging higher mortgage rates on a home

While higher mortgage rates may seem like a disadvantage, it actually presents an opportunity for you to maximize your returns and apply your interest income toward a real estate mortgage. Let's consider two scenarios to illustrate this point.

Scenario 1: 3% mortgage rate, 0% bank interest rate

In this scenario, you secure a mortgage at a low 3% interest rate, while banks are paying 0% on cash deposits. Although your mortgage rate is low, the opportunity cost of keeping cash in the bank is high, as your cash savings do not generate any meaningful returns. This can limit your overall earning potential.

Scenario 2: 6% mortgage rate, 5% bank interest rate

In this scenario, you secure a mortgage at a high 6% interest rate during a time when banks are paying a generous 5% on cash deposits. Despite the higher mortgage rate, you can generate a substantial return on your savings, resulting in a net positive income.To illustrate, here’s what you could earn in both scenarios with $1 million cash in the bank — and how it applies to purchasing a home.

	Scenario 1	Scenario 2
Initial cash	$1,000,000	$1,000,000
Bank interest rate	0%	5%
Annual cash interest income	$0	$50,000
Home purchase price	$500,000	$500,000
Loan amount (70% financing)	$350,000	$350,000
Mortgage interest rate	3%	6%
Annual mortgage interest expense	$10,500	$21,000
Net annual income	($10,500)	$29,000

In the first scenario, you are not generating any interest income from your cash reserve despite having a low mortgage rate. Consequently, you would be paying $10,500 in mortgage interest.In the second scenario, however, you have the opportunity to earn $50,000 in interest income. While you would be paying $21,000 in mortgage interest each year, your cash savings income means you have a net income of $29,000. This example demonstrates how higher mortgage rates combined with higher interest on cash savings can give you a cost advantage when you buy a home.

Ways to maximize your cash returns

In addition to capitalizing on their cash reserves, real estate investors can strategically allocate their funds to maximize returns. Here are a few ways to increase your earning potential and offset higher mortgage costs:

Short-term investments

Consider short-term options like high-yield savings accounts, certificates of deposit (CDs) or money market funds. These low-risk investments can provide more attractive returns than near-zero interest rates from banks.

Portfolio diversification

Explore alternative investment options that offer higher returns than cash deposits like bonds, stocks and real estate investment trusts (REITs). Diversifying your portfolio can help you to generate more net income despite higher mortgage payments.

Prepayment strategies

Analyze your mortgage terms to determine if any prepayment options are available. By paying down your mortgage principal, you can reduce the overall costs of your interest.

Play it smart with your investments

While higher interest rates may seem unfavorable to real estate investors, they also provide unique advantages. By leveraging the earning potential of your cash reserves and diversifying your portfolio, you can maximize returns in a changing economic landscape. This enables you to achieve a net positive return — which could be beneficial when investing in a stable and reliable purchase like real estate.And with Pacaso’s co-ownership model, you can take your dollar even further. To get started, explore our listings in some of the top second home destinations.

How real estate investors can use higher interest rates to maximize returns (+ real example)