North County Price Reductions – 3

[balasr]

First, thanks sdrealtor for the clarification in my previous post and my appreciations for posting in this forum. I have got lots of useful information from your posts. It’s good to have a sensible and straight talking industry insider here.

That said, let’s revisit the condo I mentioned last time:

1**1 MONSERRAT WAY, Vista, CA 92081.

The latest is a drop of another $30K

ZipRealty Price Track:

Price Reduced: 05/18/06 — $489,000 to $469,000
Price Reduced: 06/14/06 — $469,000 to $440,000
Price Reduced: 06/15/06 — $440,000 to $439,000
Price Reduced: 06/27/06 — $439,000 to $409,000

Days on Market: 70

Wow, a $80K drop. Shouldn’t we just rush and buy it?

Wait, let’s see if it makes any sense to buy the condo even now.

zillow sez:

Sale History
04/03/2001: $255,000
11/16/1998: $185,000

From 1998 to 2001, assuming 2.5years, the compounded return on the house was approximately 14%

The original price $489,000 set 05/18/2006 was approximately 5 years after the 2001 sale. The price is suspiciously close to a 14% annual compounded return (255*1.14^5 ~ 491). Yeah, yeah, I know – the price was actually set very scientifically by using comps in that area.

Let’s be generous and assume inflation was 4%. According to the government, the so called “CPI” (perhaps ought to be split out as *Con*sumer Price Index :-)) was less than 3% annually during this time. That means at least 10% return over inflation. As per Siegel, stocks have returned 6.6% over the last 150+ years. Think about it – Berkshire Hathaway run by financial geniuses Warren Bufett and Charlie Munger, which own many companies which actually *produce* stuff and have huge cash flow have about 9-10% return over inflation in the long term.

BTW, the current selling price comes to a compounded annual return of about 10%.

Let’s see what this dog will produce and compare for yourself with the S&P or Berkshire-Hathaway.

Let’s say I buy this by putting 82K down and get a 6.5% interest rate 30 year fixed. My payment will be 2067 + 245 (condo fees) + 430 (tax) = $2742. What would I personally pay for this townhome as rent? Not more than $1600, may be $1700 assuming the owner takes care of repairs. Remember this is in Vista and the school district while decent is not San Dieguito or anything like that. Also it’s quite close to both Shadowridge and Melrose with decent amount of noise coming in.

Let’s adopt convenience and say $1742 rent. That mean a cash “flow” of -12K per year. Ask yourself this question: What will this dog be worth in 5 years? Close to $500K so that this (negative flow + lost opportunity cost of investing 12000K per year + selling costs) will be offset by the capital appreciation? Or will it be closer to 300K?

I am betting $300K.

[sdrealtor]

All very sound analysis. Unfortunately all it takes is one nitwit to come in a pay the price. I’m with you on the price but RE markets are far from rational.People do stupid things all the time.

[an]

If you’re in the 25% tax bracket, after tax write off, you’re look at around 1700/month including tax and HOA. So, that deal might not be as bad as it look if you’re willing to front the 20% down, which is basically dead money. So, yes, it’s still more expensive than rent, this deal is getting closer to the cost to rent.

[4plexowner]

As an investor, that $1700/mo rental is not worth $300K to me.

I am expecting gross rent multipliers (GRM) in the 8 – 10 range when our market bottoms.

Let’s be generous and see what the condo is worth to an investor at a GRM of 10:

(GRM of 10) x (yearly rent of $20,400) = $204,000.

At GRM of 8 the condo is worth $163,200.

The stupid person that sdrealtor refers to may buy this condo for more but that’s what it is worth to me.

Why would anyone care what this condo is worth to an investor?

Because housing that won’t sell becomes rentals and a savvy investor buying rental units isn’t going to pay the 20 GRM that this property is currently listed at ($409K).

[ocrenter]

and once you start to have flattening or negative y-o-y appreciation, you weed out the wannabe investors. so you are left with true buyers and savvy investors. and true buyers would not touch these, so the price either have to drop or it just drop off the listing.

[Bugs]

I agree with 4plexowner – the savvy investors know that, depending on financing costs, an annual multiplier in the 8-10 range will usually throw off a little cash as long as the property doesn’t need a lot of maintenance and they don’t get the tenant from hell. Since they don’t live in these properties, an investor doesn’t (legitimately) qualify for the lending programs with the 95% financing terms so they have to put in more cash. Property taxes and long term maintenance costs have to come out of the rental payments, too.

A $500,000 purchase price results in $450+ per month in property taxes – that’s a lot of money to pay out of a $1,700 monthly rental rate.

[balasr]

Thanks for the comments 4plexowner. So it’s much worse than I thought from the investment point of view. Is the 8-10 times you mention derivable from some assumptions on costs, or is it a general rule of thumb that you have developed from your investing experience?

Thanks!

[4plexowner]

The 8-10 GRM is a general rule of thumb.

Another rule of thumb is that each year a property will cost about 10% of its purchase price to own and maintain.

For example, a $400K property is going to cost, on avg, $40K per year to own and maintain (mortgage, insurance, taxes, maintenance, etc).

For me to break even on the property I need $40K per year in rents (which equates to a GRM of 10).

I use these guidelines to evaluate potential investment property.

~

My investment experience is limited to San Diego fourplexes.

The first one I purchased in 1998 and paid about 13 GRM. The property and its location justified the higher GRM.

In 1999 I paid 11.5 GRM for a fourplex in Mission Beach and thought I was paying too much.

I purchased four more properties at higher GRMs before coming to my senses.

By 2002 GRMs for multi-units were consistently over 15 and usually 16-20. That’s when I started selling.

[barnaby33]

So by your admission it seems like you made all your profits, or at least most of them, on appreciation, rather than rental income.

Josh

[ocrenter]

so I guess GRM of 23 isn’t exactly very good for my landlord…

[powayseller]

Based on some refinance junkmail that comes here, my landlord has a GRM of about 15. BUT – how often did he refinance to pull out more cash to make more real estate deals?

[Bugs]

Yeah, he did make his profits on resale. He bought while the market was still on its way up and he could see there was room for growth – that’s what justified the slightly higher income multipliers. The better locations contributed to his decision only to the extent that it meant there was more room for growth. When the sales volumes dropped off he started selling. That’s what a smart investor does – they buy while its on its way up and they sell as close to the peak as they can.

In a rapidly increasing market, some investors will even accept a negative cash flow for a short period of time because they know they’ll make up for it when they sell. Once that situation changes, so also changes the price an investor will pay.

[4plexowner]

Yes, all my profit came from appreciation. And a big chunk of my potential profit was spent on the negative cashflow that goes along with buying properties at a GRM over 10.

[barnaby33]

What gave you the confidence to keep going after your first? I assume you aren’t an independantly wealthy person. Especially if you were negative each month.

Josh

[4plexowner]

Short answer: prices kept going up.

I’d buy a property and one year later it would provide the cash (via refi) to buy the next property – it seemed like a no-brainer at the time.

Cashflow grew more negative with each refi and subsequent purchase but I had income from my job to cover most of it and the refi’s covered the rest.

Rents were also rising so I could pretend that what I was doing made sense.

It finally dawned on me that I was not ‘investing’ in real estate – what I was doing was speculating on higher prices and rising rents.

[Author]

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