The Double Dip's Official: Home Prices Fall to New Low

[Santayana]

My relatives just bought a place at one-third the price of what it last sold for in 2006.

 

In certain places in Florida an all-cash buyer can earn around 12-14% annual yields right now.  That is after taxes, insurance, and association fees.  Completely free option on future appreciation.  If only I knew how to be a landlord, and had the time - oh, and the cash!

 

How are you calculating that 12-14% yield?  It sounds like you may be assuming $0 for  vacancy loss, management expenses, and maintenance costs.  After 15 years in the rental business I can tell you that 1 bad tenant can wreck your numbers in a hurry!

[enoch01]

My relatives just bought a place at one-third the price of what it last sold for in 2006.

 

In certain places in Florida an all-cash buyer can earn around 12-14% annual yields right now.  That is after taxes, insurance, and association fees.  Completely free option on future appreciation.  If only I knew how to be a landlord, and had the time - oh, and the cash!

 

How are you calculating that 12-14% yield?   It sounds like you may be assuming $0 for  vacancy loss, management expenses, and maintenance costs.   After 15 years in the rental business I can tell you that 1 bad tenant can wreck your numbers in a hurry!

 

I'm sure you are correct!  I was excluding everything except taxes, insurance, and homeowner's association fees (which can include quite a bit of outside maintenance in many Florida communities).  Vacancy loss and management expenses are excluded.  So I'm curious, as a 15 year veteran: where's your business (just general geography), and what do you think of the market in your area at the moment?

[Santayana]

I've been out of the business since 2007 when we moved away from the SF Bay Area, so I don't have any specific insight to conditions right now.    I just want to stress to anyone considering getting into the rental business to account for the fact that your property won't always be occupied, or even worse may be occupied by someone who stops paying their rent and trashes the property while they are there.    Evictions are not always easy or quick, and are yet another expense to deal with if you engage legal counsel.

[Myth465]

I've been out of the business since 2007 when we moved away from the SF Bay Area, so I don't have any specific insight to conditions right now.    I just want to stress to anyone considering getting into the rental business to account for the fact that your property won't always be occupied, or even worse may be occupied by someone who stops paying their rent and trashes the property while they are there.    Evictions are not always easy or quick, and are yet another expense to deal with if you engage legal counsel.

 

This is why I stick to REITs and Equities. My folks owned houses and while its great if you dont have much else to do with your capital inmo it isnt worth the headaches unless you can get a 20% return assuming no inflation in rents or housing and with an adequate allowance for vacancies / repairs. One roof, crummy tenant, or just bad buy can screw up even the most conservative ROI calculations. I can get 10% yield with low risks in the market, now if only I could find cheap long term leverage......

[enoch01]

Myth and Santayana,

 

Good points, both of you.  I'm an ignorant outsider of the industry, just observing that in certain places, prices seem to be getting...interesting.

[mevsemt]

I think ubuy2wron hit the nail on the head when he called it "the perfect Dhando investment."  Myth, you probably can't get a 20% ROI if there's no increase in rents or housing appreciation (but you'll still do slightly better than breaking even).  However, IF there is an increase in rents or housing you can easily find yourself with IRR or 30% to 50% per annum (btw if you think inflation is around the corner this is not unreasonable).  I think the key is to find properties that are cash flow positive even after appropriate allowances are made for vacancies, repairs, mgmt fees, etc.

[Santayana]

Of course the difficulty is determining how much is an "appropriate allowance" for those things, and it's much harder if you're talking about 1-2 properties vs. a larger number where you can rely on averages a bit more.

[Myth465]

Of course the difficulty is determining how much is an "appropriate allowance" for those things, and it's much harder if you're talking about 1-2 properties vs. a larger number where you can rely on averages a bit more.

 

I looked into forming a partnership in 2008. I always thought if I got into this business I would want scale. Maybe 10 properties with a few partners. That way we could withstand a one off disaster. At the end I concluded that realty is a tough way to make easy money  :).

[ERICOPOLY]

Suppose you get one of those HomePath deals where you put 10% down, and you buy a home with a cap rate of 10%.  I'm not sure what interest rate you get with that, but I'm guessing about 6%.

 

I think that's a 46% yield on your invested equity.

 

46%!

 

So if this were a stock, you might say it trades at roughly 2x pre-tax free cash flow.

 

And this doesn't even consider the other part of the equation:

A 10% property price increase doubles your equity, plus you get the yield on top of that.  You should be begging for high nominal price inflation, as that's where you get your biggest bang!  Besides, rent inflation drives up your interest coverage ratio... you will be routing for Bernanke.

 

Now here is an asset class any dummy can understand, yet people are passing it up.

 

 

[ubuy2wron]

I've been out of the business since 2007 when we moved away from the SF Bay Area, so I don't have any specific insight to conditions right now.    I just want to stress to anyone considering getting into the rental business to account for the fact that your property won't always be occupied, or even worse may be occupied by someone who stops paying their rent and trashes the property while they are there.    Evictions are not always easy or quick, and are yet another expense to deal with if you engage legal counsel.

 

This is why I stick to REITs and Equities. My folks owned houses and while its great if you dont have much else to do with your capital inmo it isnt worth the headaches unless you can get a 20% return assuming no inflation in rents or housing and with an adequate allowance for vacancies / repairs. One roof, crummy tenant, or just bad buy can screw up even the most conservative ROI calculations. I can get 10% yield with low risks in the market, now if only I could find cheap long term leverage......

One bad tennant can screw up your ROI .....  and its hard and expensive to get rid of a tennant. Do you have any idea what kind of havoc a loose cannon CEO or other senior manager can do to your investment returns and how difficult it is to get rid of them if you do not own 50% plus of the stock. Its all relative I think that most of us appreciate the fact that with a click we can make our problem investments go away. I have learned from the real estate pros that a good tennant is just as important as a great price

[JSArbitrage]

If you wanted to get into RE, I think it'd be crazy to do single family homes.  First, your revenue is too concentrated.  It's like investing in a company with 1 source of revenue.  Secondly, competition is very high.  You are competing against people who might have paid that home off years ago and are just looking for some extra cash each month.  Or people that are underwater so they refuse to sell and just want to pay off some of the mortgage.  Or, if it's a vacation area, you are competing against people that just rent it out for some extra cash in the off-season; they fully intend to lose money on it.  Lastly, prices are held up by economically irrational buyers (i.e. they aren't crunching the numbers on a cap rate basis.  They are buying because they can afford it and their wife liked the granite counter-tops.  Lots of "goodwill" value in homes for people.)

 

I'd much rather take the debt side of housing, particularly of the hard money variety.  There is an active market for people looking for short-term, high-interest money and there are investors willing to pay for it.  I'd much rather broker a $100K loan to a group of high net worth investors and take my commission. It's better than putting my money at risk and unclogging toilets of tenants.

 

Of course, you could buy a high-moat company selling for a reasonable P/E with a growing imbedded coupon and play golf and sleep tight.  Whatever floats your boat.

 

I just think owning single family dwellings as an investment is for the birds.  I'll take a 100% passive 10% over a middle-of-the-night repair trip for 15% any day.

[ERICOPOLY]

Secondly, competition is very high.  You are competing against people who might have paid that home off years ago and are just looking for some extra cash each month.  Or people that are underwater so they refuse to sell and just want to pay off some of the mortgage.  Or, if it's a vacation area, you are competing against people that just rent it out for some extra cash in the off-season; they fully intend to lose money on it.

 

That point about competitive pressures on rents is true today, it was true last year, it was true 10 years ago... etc...

 

What matters is this... why will the competition increase?  Why hasn't this already happened?  If competition hasn't yet hit a zenith during a long period of housing oversupply, when will it ever?

 

Home-building at record lows nationwide, especially in the most oversupplied areas.  This is favorable for the future direction of rents.

 

Lastly, prices are held up by economically irrational buyers (i.e. they aren't crunching the numbers on a cap rate basis.  They are buying because they can afford it and their wife liked the granite counter-tops.  Lots of "goodwill" value in homes for people.)

 

The buyers aren't irrational in areas where cap rates are 10+%.  So as long as you are right on your cap rate being 10%, then you have eliminated this concern.

 

 

[Hawk4value]

I'd much rather take the debt side of housing, particularly of the hard money variety.  There is an active market for people looking for short-term, high-interest money and there are investors willing to pay for it.  I'd much rather broker a $100K loan to a group of high net worth investors and take my commission.

 

I totally agree with you. I believe in this market HMLs are the way to go. As long as you lend at 60 to 70% loan to value and have a 1st mortgage on the property. If the borrower defaults then you can foreclose at a cheap price. Great way to "buy" real estate.

[ragnarisapirate]

A lot of the stuff being discussed here depends on where you are located. Where I am, if I really want to, I can go through the court system and get a tenant out of a house in less than 2 weeks. Often, they will just leave on their own. Even if a place is trashed, it is easy to fix stuff, and isn't that expensive (if you know good/cheap contractors or have developed a good system). Additionally, if you know much about property maintenance, you can do things a lot cheaper too...

 

For example: I literally just walked in the door from fixing an air conditioning system, at a cost of under $50 bucks, all because I know certain things to look for. Had I needed a contractor, it would have been hundreds, at a minimum, AND they probably would have told me I needed a new system. Additionally, if you buy right, you can get well over 10%+ returns, even when you pay cash (leverage, at present rates, will increase returns.) For example: I have a house that had I paid cash on it, would have generated over 33% annualized; in rent, less expenses . I recently paid cash for another one, that if I keep as a rental, will conservitavly generate above 18% in returns, net of all expenses. Again, that doesn't include the appreciation in the price, from where I got a hell of a deal on it; it was a 60 cent dollar. In both of these cases (like the rest of my houses) I work a lot less than anyone I know, have decent income, and can focus on other pursuits (like stocks).

 

What I am getting at is this: Rentals are just like stocks: you generally need to do a ton of research to invest in them and do well. Selectivly, there are great deals out there; you just have to be patient and try to not do anything stupid.

 

Additionally, as it was mentioned, if there are any people on this board that are hard money lenders (or know people that are), drop me a line. I'd love to talk to you about terms, rates, and such, as I always like to see what is available in comparison to the banks (and potentially, some local hard money guys) that I have talked to.

[mevsemt]

That's true, it's all about location.  Based on very preliminary due diligence, in Atlanta (i.e. surrounding area, within 20 miles of downtown) you can find single family houses selling <60x one month's rent, so a typical transaction might look something like this:

 

Purchase price: 60K

Monthly rent: $1100

 

Initial Cash in (10% downpayment, closing costs, prepaids, ~4K in rehab): 12K

 

Pro forma revenue (assume 1 month vacancy): $12.1K

 

Less

Operating Costs (Mgmt company placement & admin expense, taxes, insurance, repairs & maint): ~6K

Mortgage Payments (principal & interest, ~6.5% rate, 30 yr fixed): ~4K

Total pro forma expenses: 10K

 

Cash profit: $2,100

(As % of Cash In): 17.5%

 

17.5% return on investment is VERY attractive IMO.  But here's kicker, this house might've sold for 150K to 180K at peak, so maybe it'll be worth 80K to 100K in 5 years (or maybe not).  So basically your downside is limited by the cash flow, but the upside from paying down principal and any appreciation is all gravy...

 

Thoughts?

 

 

 

 

 

[ragnarisapirate]

That's true, it's all about location.  Based on very preliminary due diligence, in Atlanta (i.e. surrounding area, within 20 miles of downtown) you can find single family houses selling <60x one month's rent, so a typical transaction might look something like this:

 

Purchase price: 60K

Monthly rent: $1100

 

Initial Cash in (10% downpayment, closing costs, prepaids, ~4K in rehab): 12K

 

Pro forma revenue (assume 1 month vacancy): $12.1K

 

Less

Operating Costs (Mgmt company placement & admin expense, taxes, insurance, repairs & maint): ~6K

Mortgage Payments (principal & interest, ~6.5% rate, 30 yr fixed): ~4K

Total pro forma expenses: 10K

 

Cash profit: $2,100

(As % of Cash In): 17.5%

 

17.5% return on investment is VERY attractive IMO.  But here's kicker, this house might've sold for 150K to 180K at peak, so maybe it'll be worth 80K to 100K in 5 years (or maybe not).  So basically your downside is limited by the cash flow, but the upside from paying down principal and any appreciation is all gravy...

 

Thoughts?

 

 

 

 

 

 

That's pretty attractive, especially if you have a financing package you like. I do have a question though. Are you able to find any $60K houses that are worth, say, $85K?

 

The operating costs seem a bit high. Here, you can find a management company for a month's rent, though, repairs will be tacked on to that. You would have to find some REALLY bad tenants to have $6K in expenses!

 

Additionally, one thing to remember is that your rents may fall. When a lot of other people start getting the deals you discuss, they will be willing to cut their margins to keep the places occupied. As more and more people lose their houses, this will continue to be the case. Though, you would have to screw up pretty badly to make a 60 month rent house not work.

[mevsemt]

That's true, assumed operating expenses are probably high, but it's always better to be conservative in your assumptions...

 

Anyway, I assumed about 3K for taxes and insurance.  Ongoing mgmt fees are 10% of rent.  Placement costs are 1 months rent (I assume this is incurred every other year).  And I assume normal wear and tear ends up costing one month's rent per year. 

 

Keep in mind I'm modeling this in such a way that it's a totally passive investment - I never want to meet or talk to the tennants, no late night phone calls, etc. 

[ragnarisapirate]

If you're never wanting to meet the tenants, that's probably pretty reasonable. Your insurance and taxes may be a bit high. My taxes are 1% of the property value, with insurance on a house with a reconstruction cost of 80ishK being something in the neighborhood of $375/year.

[mevsemt]

Ha! Found money!

 

I appreciate the input.

[ERICOPOLY]

Not sure why, but you subtracting principle payments from "profit".

 

This is similar to a corporation taking a charge to earnings for paying down debt.

[mevsemt]

I think that's just semantics, I shouldn't have used the term "cash profit."  I did mention at the end of my post that paying down principal was not included in the "cash profit" calculation.  Anyway, in my detailed model all these things are laid out much more precisely.

[ERICOPOLY]

So perhaps you just want to know how much you can walk away with if the house price keeps on declining.

[keerthiprasad]

Those look like some great numbers.

 

I am currently starting a partnership focused on residential properties with an experienced operator.  We are not really able to get loans on the 50k properties we are buying at a reasonable cost (too small for most banks or the costs are not worth the trouble).  Regardless, in areas not prone to excessive development we are finding that we can safely assume a cap rate of ~12-14%.  With multifamily properties we are looking at much higher numbers, as leverage is easy to obtain.  However, prices on multifamily units tend to be more dependent on income streams, whereas individual residential properties seem to have the "homeowner" premium that people will pay.  And personally, I think the final sales gain is the gravy everyone is looking for.

 

One word of caution to anyone looking to do this...Professional management companies are always very prudent in containing costs and this can really eat into your bottome line.

[turar]

That's true, it's all about location.  Based on very preliminary due diligence, in Atlanta (i.e. surrounding area, within 20 miles of downtown) you can find single family houses selling <60x one month's rent...

 

Which area of Atlanta are you finding houses selling for 60K with 1100 rents? I know Atlanta varies significantly from area to area, and some neighborhoods can be downright scary to even drive through.

[mevsemt]

I'm not looking in Atlanta specifically, but rather the surrounding suburbs (Gwinnett, Dekalb, Cobb, etc. counties)... think blue-collar, working class suburbs.