Acquiring Rentals in an Appreciating Market

[Dan M.]

In a market that has quickly appreciated over the past three years, I am looking to obtain cash flow properties. If I run the numbers on an income-property and the cash flow is acceptable as well as the long term ROI, some would look at the calculations and say that's a good deal. My concern is acquiring one of these properties at the price they're asking, and then the market calming down again and I now have a home that is worth less than I'm paying (negative cash flow).

I feel like the houses I'm seeing are not worth what everyone in town is asking. How do you determine the actual value of an income-property so you pay the best price for when the market goes back down?

[Dan M.]

I just noticed there are 18,728 unanswered forum posts. I'm going to have to include keywords as if this is twitter: San Antonio, Texas, Bexar, rentals, income-property, cash flow, investor, duplex, triplex, fourplex, multifamily, multi-family.

[Kristopher Williams]

The market in San Antonio isn't as volatile as other markets. for the most part it's been a steady increase of appreciation in homes. And you said the prices people are asking is too high. You could always market for a fixxer upper at a cheap price but ofcourse normally a cheap price will come with it's own set or repairs. 

[David Thompson]

Dan

Re: SA, pop and job growth has been solid and looks to continue that trend. Valuations could stabilize and retreat, but if you are focused on cash flow not appreciation, a SFR or MF bought right, with great property mgt in solid areas of town should still make money IMO. Im personally buying MF in NE SA close to I-35 corridor on way to Austin. The long term trend is in place. I dont see anything stopping growth along this corridor. New Braunfels to Georgetown, towns along it are some of the fastest growing towns in the country

Texas for 12 yrs in a row leads country in corp relocations. Low cost of living, good quality of life, favorable business climate, landlord friendly, diverse industries, educated workforce, warm climate are trends that have been in place for years and is continued to 2030. 

You still want to ensure your cash flow numbers work, I worry less about predicting where values are and could go. Im seeing $400/mo net per door on new fourplexes which gives me plenty of flexibility to handle a slowdown when that happens.

[Dan M.]

$400 a door is amazing! I'm been running numbers on other MF in different areas throughout the city and I'm looking at maybe $400 total if even that. I'm guessing at most of my numbers since I don't have the experience such as rehab or repair costs. I'm also winging it on water and closing costs. Alright I'll admit, most of my numbers are educated guesses based on patterns of prices through research. I'm an analyst by trade so I have tons of excel sheets trying to figure these numbers out. Thanks for the information @David Thompson! Is your primary interest (besides cash flow) the school? I heard Elementary schools are the most important.

[Russell Brazil]

I dont know anything about San Antonio, but unless it is a dying city like Detroit or Flint (Sorry Michigan Peeps) then there is a very high probability that in 15 years the property will be worth more than it is now. Im pretty confident that even if someone purchased at the peak of the bubble, that if they hold on for 15 years in any market, their properties values will go up. Inflation can not be avoided and it is the friend of the long term buy and hold investor.

[JD Martin]

You are confusing cash flow with asset value. Theoretically, a property could have a hard asset value of zero, or negative value as you've projected, and cash flow of infinity - say a billion dollars per month. Reality is that if you have purchased properly, meaning that your expenses are low relative to your profit, you will continue to see healthy rental income. Markets that have declined in value often see upticks in rent prices, as more people are shut out from buying and inventory drops from people who don't have to sell waiting it out.

[Dan M.]

Thank you gentlemen, I think I'm tracking now. Please let me know if I'm wrong... @JD Martin, your last sentence made it click. As an example: If I paid 200k for a duplex in today's market, each tenant is renting at $800 and I'm receiving $200 cash flow, houses could be valued at 150k after the market goes down. I was concerned other landlords could offer lower rents in the same area and still cash flow nicely since their mortgage loan would be lower and my vacancies would increase. You're saying houses become more affordable so there is less inventory thus leading to higher rents (supply & demand)? 

Your first sentence left me puzzled. Am I confusing cash flow and asset value, or that I didn't have a clear picture on supply & demand? I understand that equity and a hefty price-per-door provides a nice cushion, but I was basing my question on the fact I'm very new to evaluating a deal and all the actual costs for my market so all my cash flow numbers look low. This left me short-sighted and only thinking of the loans we acquire at each part of the market cycle and how that would affect those who landlord and bought at the highest peak and those who can offer lower rents to fill vacancy because they bought in the valley. (Analog signals).

@Russell Brazil, haha no way. San Antonio is definitely not Detroit! Toyota is only a sliver of what San Antonio has to offer.

[Richard Dunlop]

Originally posted by @Russell Brazil:

I dont know anything about San Antonio, but unless it is a dying city like Detroit...

Stop reading the 10 year old newspaper strips your mother put in your outhouse for toilet paper. I'll pay for a magazine subscription for you so you can catch up with what the rest of the world already knows about Detroit. 

[David Thompson]

Dan

For my SFRs in Austin, being in good school districts is one of my main criterias. For fourplexes, the demographic seems to be people who are moving out of apts because they have very young children and want a small yard for a pet, but dont have the capital or credit to purchase. Im not in bad school districts but schools dont have to be as high in my criteria as my SFRs. Keep in mind ,finding zoning for new fourplexes is very hard. Builders usually have to go further out from the city. These are in Selma and Universal City, right off I-35....the growth of this corridor is palpable.  Ten minutes from New Braunfels which is one of the fastest growing towns in U.S. Tons of logistics, distribution centers...Amazon close by and expanding.

[JD Martin]

Originally posted by @Dan M.:

Thank you gentlemen, I think I'm tracking now. Please let me know if I'm wrong... @JD Martin, your last sentence made it click. As an example: If I paid 200k for a duplex in today's market, each tenant is renting at $800 and I'm receiving $200 cash flow, houses could be valued at 150k after the market goes down. I was concerned other landlords could offer lower rents in the same area and still cash flow nicely since their mortgage loan would be lower and my vacancies would increase. You're saying houses become more affordable so there is less inventory thus leading to higher rents (supply & demand)? 

Your first sentence left me puzzled. Am I confusing cash flow and asset value, or that I didn't have a clear picture on supply & demand? I understand that equity and a hefty price-per-door provides a nice cushion, but I was basing my question on the fact I'm very new to evaluating a deal and all the actual costs for my market so all my cash flow numbers look low. This left me short-sighted and only thinking of the loans we acquire at each part of the market cycle and how that would affect those who landlord and bought at the highest peak and those who can offer lower rents to fill vacancy because they bought in the valley. (Analog signals).

@Russell Brazil, haha no way. San Antonio is definitely not Detroit! Toyota is only a sliver of what San Antonio has to offer.

 Yes, confusing cash flow and asset value. There does not have to be any statistical correlation between the two, although there usually is to some extent (i.e. if something produces cash flow, it is going to likely have more value as a hard asset than something that does not, all things being equal).

Let's use an extreme example of some war-zone in Detroit. Let's say you buy a house for $10,000. You do $10,000 worth of improvements to get the property to a habitable state and now you've got $20,000 in it. You put it up for rent for $250 per month, which is what the area that you own will hold because it's a war zone. You get reliable renters (ha! at this price? in this neighborhood? But I digress :D  ). A year later there's a major depression in Detroit and you try to cash out on your house, only to find it's only worth $10,000 - you've lost $10,000 in asset value. What does that mean for your cash flow? Nothing. You still have people paying the rent at $250/month. 

The further up the food chain you go, the greater the risk of the scenario you outlined - that your mortgage, relative to all other mortgages in the pool of rental investment, is higher, leaving you less able to cut prices in the case of oversupply. But for you to make that leap, you have to have access to a whole lot of information at once, and also be able to predict how your particular market will respond to both micro and macro economics. All investing involves some risk, and while it's possible that your market could experience falling asset values, falling rent prices and reduced supply of renters all at the same time, it's not terribly likely, and even those scenarios can be hedged against if you purchase properly - meaning your spread between expenses and revenue is great enough to cover those contingencies. 

If it's any consolation, "perfect storm" conditions usually revolve around boom towns or single-industry areas - oil towns, car towns, etc (Dallas/Houston in the 80's; Detroit in the 90's/00's) - and are often coupled with governmental incompetence of foolhardy spending. If your community has a diverse economy, and a reasonably well-run government (what do Moody's/Fitch say about their ratings, for example?), most economic fluctuations are barely even noticeable. 

[Dan M.]

First off, I want to say thank you to both of you for providing your knowledge and expertise to a new investor. Very much appreciated!

@David Thompson, I will keep everything you said in mind as I look for a potential first income-property. 

@JD Martin, I now smell what you're cooking. You really broke it down for me and I needed that, I really like your answer. I can now move forward to the next roadblock that is being broken down thanks to David Thompson's help (finding the right area). Two birds with one stone!

You both have provided some great info and I look forward to one day returning the favor.