How to get a 13% cash on cash return in Stockton

[Matt Shamus]

@Billy L. and several others have asked me why I like the Stockton market, so I figured I'd share my perspective on the market and an example of how I achieve a 13% cash on cash return. I'd love to hear your thoughts. 

Stockton was hit hard during the great recession and is still recovering as of summer 2015. It had the honor of being the most populous US city to file Chapter 9 Bankruptcy at the time (2012). It's now getting a boost from a slowly but surely improving local economy and a quickly improving Bay Area economy. Despite the progress, Stockton still has a long way to go. I think its colored history and incessant bad press scare a lot of investors away. I love that because it means less competition. I live in the Bay Area and many real estate investors here won't even consider Stockton. They think it's too risky.

While I do believe Stockton real estate values will continue to appreciate, that's not my primary motivation for being in the market. I like it for the strong cash flow and what I believe to be relatively low risk. I should caveat here that my strategy is to offer the nicest single family rental available in a Class B neighborhood. This allows me to attract what I believe are the best tenants in the area to nearly every property I own. Great tenants treat the property well and require less hand holding than average tenants. They can also afford to pay slightly more and are more likely to pay on time every time. 

Most markets in the Bay Area won't come close to cash flowing the way Stockton does; real estate there is way too expensive. While Stockton may not yield numbers like you might find in Memphis, it can provide strong cash on cash returns with relatively low risk. 

Let's consider an example. In the spirit of transparency, below are real numbers for 2014 for a duplex I own in Stockton. I was fortunate enough to purchase this property with zero money down, but let's use a 25% down payment to illustrate what the cash flow looks like with a more traditional purchase. 

Purchase price: $160,000

Down payment: $40,000

Loan: $120,000

Monthly Income

Rent: 1,755

Monthly Expenses

Property tax: -196

Insurance: -64

Yard: 0

Prop Mgr: -140

Vacancy/Maintenance: -170

Garbage: -35

Water: -120

Net Operating Income: 1,030/mo. (12,360/year)

Debt service: -588

Cash flow: 442/mo. (5,304/year)

Cash on cash return: 13%

A couple notes on the above. Property tax is a bit high and was recently assessed downward by the county at my request and after providing some documentation. We opted for a no maintenance yard which eliminates the normal monthly expense for mowing, edging and blowing. I like doing this on a property whenever possible. I have a property manager for this particular property because the tenant profile is slightly below what I am comfortable dealing with myself. (Even if I manage the property myself, I include the expense as a line item when calculating my return). Water expense is high (which reminds me I need to do take some action to lower it!). 

Bay area investors - I'd love to hear your thoughts!

Matt

[Kyle J.]

Good write-up @Matt Shamus. 

I also invest in Stockton so I'll share some of my numbers to show yours aren't an anomaly and to hopefully answer some of the questions raised about vacancy rate and appreciation. 

I'll use examples of two SF houses I bought back in 2013.

One was purchased for $94k, and I put about $21k into it ($115k total). It currently rents for $1075/mo (which is under market). I recently had it appraised for $180k when I took a $100k HELOC out on it.

The other was purchased for $110k, and I also put about $21k into it ($131k). It currently rents for $1195/mo. I recently had it appraised for $185k when I took a $110k HELOC out on it.

The actual vacancy rate on both houses for 2013, 2014, and 2015 has been 0%.  However, to give a better idea of the local vacancy rate, I ran the numbers on all of my properties during that same time period and found that it averages 2-3%.  (I budget for around 8% vacancy but have never had it that high as the rental market is very strong and I usually find renters within 1-3 days of having a vacancy.) 

I self-manage my properties and don't pay any utilities (i.e. no water/garbage, no gardener, nothing).

I've challenged my assessed property tax values before when I felt they were too high, and I've always succeeded in having them lowered (because I had substantial documentation supporting my position).  However, overall, I find the local property taxes to be very reasonable (especially compared with what I hear others talk about from around the country).