Is it worth investing in an over-priced market?

Question

I could really use the knowledge of experienced investors here.

I live in San Antonio, TX. I have yet to invest in the real estate market (I'm a newbie who hasn't gotten their feet wet yet) and have so far been doing some rough estimate number-crunching. I scan sites like Trulia to check out rents based off sq ft and throw in 50% expenses, 10% PM, 8% vacancy, 3.5% mortgage, and 5% down-payment. I utilize a couple spreadsheets I found here on BP.

A lot of the properties I see appear to be overpriced. It looks like the investor would be lucky to even meet the 1% rule (if you were to buy at the current market) with market rents, and the cap-on-cap rate would be about 4-8%. The cash-on-cash return would also be pitiful until the mortgage starts getting paid off.

Scenario example:

$150,000 house

$7,500 downpayment

3.5% mortgage

8% vacancy rate

$1300 rent

Roughly 57.47% expense projections

Based off my calculations, I wouldn't even get positive cash flow from this property until about year 9. The rent, at this price, is realistic though. The market here in SA is booming. The inventory rate is roughly 3.6-3.8, and it is an apparent seller's market based off my market research and in conversation with a mortgage loan officer I know.

I can live with a few hundred dollars annual negative cash-flow as I work full-time and don't plan on quitting anytime soon. This does mean that I would be getting negative cash-flow where I could get positive if I didn't add 10% to a Property Manager. I also do understand that a bigger down-payment would help generate cash-flow, but I'm then depriving myself of lump-sum cash that I could use for contingency expenses.

Q1: Would it be worth investing in this hot market? I'm afraid we might be in a bubble, and I might come to experience negative equity if I purchase property that will end up depreciating in value.

However, my research indicates that the population is growing about 5-10% per year. SA is bringing in sizable business and economic growth is probably situated around 3.5% per quarter. The federal reserve bank of Dallas has data showing that SA is experiencing a boom within the business cycle.

Q2: Is it better to put down a sizable down-payment, or to save it for other purposes? Cash is king, and present cash is better than future cash.

Any advice would be appreciated! If any investors here live in SA, I'd also love to pick your brain on the local market.

Edit - If anyone wonders about the 5% down-payment - I'm looking at living in a house with a VA loan for a couple years before I move on to another property and rent it out. A 5% down-payment isn't necessary, but every little bit helps reduce the mortgage.

Travis Sperr · Answer

Overpriced is all relative. Deals are available in every market at all times, all has to do with how hard someone is willing to work and the network surrounding you. You often see posts of how overpriced Denver is, I just bought a town home for $165k that rents for $1,700 per month - right off the MLS.

If the true strategy is buy and hold for a long time the price today isn't relevant, the prices could go up 20% higher or drop 20% in the next 5 years. Buy deals that the numbers work today and have money in reserves for tough times.

I have never heard someone say they are not investing in their 401k because the stock market is overpriced. Slow and steady always wins the race.

Seth Teel · Answer

First and foremost, "the Rules" don't always apply and don't have to apply.  The 1%, 2% rule, 70% rule, etc.  Those are just easy go-to methods to help evaluate a potential deal quickly.  Each should be adjusted accounting for chosen market, comfort level, investment strategy, long-term/short-term old, and for many other reasons.  Use "the rules" as a starting point, but not an end-all be-all for determining whether or not you purchase an investment.

You are correct, SA is a hot market, but many investors are still purchasing SFRs, duplexes, and MF with great monthly cash flow (many of these off the MLS or from over-priced wholesalers).  As you mentioned, I really wouldn't worry about San Antonio being a bubble market.  Unlike Dallas, Houston, & Austin, San Antonio does not have the severe spikes in property values, nor does is have the quick drops.  San Antonio's market tends to plateau more than it builds and pops.  That being said, you can still buy smart in a bubble market.  When I look for rentals, I need a property I can purchase with equity, will appreciate, and can cash flow from day one.

In order to capture equity you may want to look at purchasing a distressed asset with a hard money loan, then refinancing out in 6 months instead of purchasing with a VA loan.  Alternatively, you may want to look at purchasing a duplex of 4-plex with a FHA loan, living in one unit & renting out the other(s) for a year or two, then holding it strictly as an investment.  I have done this several times and have only purchased duplexes where one unit's rent can cover 75% - 100% of my PITI.  This way when I move on it's guaranteed cash flow.

Lastly, location plays a big part in appreciation and making sure you weather the storm in/when the market plateaus or takes a dip.  Many investors here buy rentals on the NW and NE sides. They buy 80's 90's built tract built homes in predominately rental neighborhoods. They may get decent cash flow, but their property values are generally stagnant.  Those that are buying older homes inside of 410 (closer to the urban core the better), will buy at lower prices (except for super hot areas Tobin Hill, Lavaca, Dignowity Hill, Beacon Hill, Alta Vista, etc), will see appreciation over the next few years, will have high demand, low vacancy rates, and be taking advantage of all the growth/development going on in and around downtown.  In the 4 years I've owned my duplex in Lavaca, I've never had a vacancy, and only had to advertise it for rent once (I had 18 showings within 4 days and had applications. This property has also seen appreciation of over 50%.

Everything I've written above is based on my personal experiences and/or that I've seen from my clients, fellow investors, consulting other agents.  I am not saying you won't achieve your goals going a completely different route, this is just my 2 cents on the market and how to tackle it.   Hope it helped.

Russell Brazil · Answer

The numbers espoused on BP often do not work in some of the more expensive markets like DC, San Francisco, Austin, Boston, NYC etc......that does not mean that investing in these areas is bad, it is just that your investment criteria needs to be different.  I am much more likely to experience significant appreciation in these expensive markets, but maybe not necessarily experience the cash flow that is important to most small investors.  I think the best long term strategy is to begin with a base of cash flow properties, then after you have that base to move onto adding properties to your portfolio that are likely to experience a good deal of appreciation.

Cash flow is how I pay my bills.  Appreciation is how I build wealth.

Mark Ferguson · Answer

in my opinion the 2 percent rule is for very low end properties where the expenses can be very high relative to rents and purchase price. The more expensive house the less the expenses usually are relative to price.  The 50 percent rule is pretty worthless too. Taxes in Texas are 5 times what they are in colorado, but the 50 percent rule ignores that fact.

I'm still buying in greeley.

Ned Carey · Answer

Virtually all markets are overpriced when looked at by new investors. You typically look at median houses at full market price, then look at the rents and they don't cash flow. That is not just because the market is overpriced, it is often because you are looking at the wrong neighborhoods or deals.

It sometimes takes a while to find the kind of deals that make sense. It is much tougher in some markets than others. But I bet within 1 to 1 and 1/2 hr drive there are deals that will make sense.

To answer your question more directly - no, it does not make sense to buy in an overheated and overpriced market. There is an exception, that would be if you get lucky and find an exceptional deal and the numbers are really good, despite the market as a whole. .

All markets go through cycles.. Buy when the prices are low. Sell when the prices are high.  When the prices are high, other strategies may work but it is not the time to buy more rentals to hold.

Mike Hurney · Answer

@Russell Brazil

"I think the best long term strategy is to begin with a base of cash  flow properties, then after you have that base to move onto adding  properties to your portfolio that are likely to experience a good deal  of appreciation.

Cash flow is how I pay my bills.  Appreciation is how I build wealth."

That's what I did!

Justin Kane · Answer

@Seth Teel@Greg  H. both have excellent points, I would encourage you to scrub through their posts and learn from them

Rick Pozos · Answer

There are definitely deals in any market, especially in San Antonio. The trick is to buy from a "motivated seller". What exactly does that mean, well, it means different things to different people. To me, the seller is usually behind on the mortgage, taxes, both, or has a property that needs some repairs that they can not take care of because of their financial and/or medical condition.  Or it could be a combination of several of those conditions. It could also be that the sellers inherited a home that they do not or can not fix. Maybe a couple is getting a divorce and neither one can afford it on their own.

Marketing and networking is where you will be able to find deals.

Greg H. · Answer

@Corey Berry

My best advice to you as a Broker and long time Investor is to never trust Trulia/Zillo in Texas as we are a non-disclosure state meaning that sales/rental info from the MLS is not disclosed.  Please enlisted the help of a real estate professional to help in your purchase

John Blackman · Answer

Don't get anxious to get into a deal.  You make your money on the purchase, so you will have to look at a lot of deals to find the diamond in the rough.  Austin is growing and prices keep going up.  Every year I look back and think, wow I should have bought that lot when I thought it was overpriced back then.  So building works well in growing markets because there is tight supply.

For buy and hold, I will echo Rick Pozos.  Find the motivated seller.  This is where you will make your margins.  If you just go shopping on the retail market you can still grow over time, but it will likely take longer.

Is it worth investing in an over-priced market?

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