Is Texas as cheap as it seems?

Question

While doing the due diligence for an apartment building in Texas I noticed that the property tax rate was quite high compared to many other states.  I understand the state has no income tax, but that's not relevant to out-of-state investors.

I think when we look at Texas properties, we should consider the real price to be about 25% higher than what we pay to account for this tax differential.  Here's how the numbers look to me based on a simplified example:

Gross Scheduled Rent: $200
NOI: $100
CAP: 10
Purchase Price: $1,000

Comparing Texas's approximately 3% property tax with a state that has 1% property tax, we get a 2% hit each year based on the property value, which means the real comparable NOI is lower by $20.

Thus, comparable NOI = $80
This means we should have paid $800 for the property and not $1000.

If we do not account for this while comparing investment opportunities in different states, we could end up paying a whopping 25% more for a texas property than a comparable property in a state with lower taxes.

I understand there are ways around this, such as setting up a C corp, taking salaries out, etc. but none of them are costless.

Anyone having a contrary viewpoint?  Or a solution to this problem?  If it were a small difference, I would not think much about it but paying 25% extra seems like a lot to me.

Rich Weese · Answer

Will- what is happening with the lending?

Vikram- Here is how I judge it. I have homes I bought in TX that rent for $1000 per month. What do I have to pay for a home in CA that will rent for that? The taxes on my home in TX will be about 2.5% . In CA, 1% 
If my 2.5% is LESS in total taxes than the 1% in CA and I'm earning the same rent, then I go to the next step. What did I have to pay for the house in TX that generates the $1000 and what did I have to pay in CA for the same? 
     If my taxes are 1000 a year more, $86 per month, it is equal to about 14K in property value for the same payment. In every situation, I come out ahead in TX because of the low median price homes. Thanks for the e-mail Vikram. I'll be trying to answer all this weekend. Rich in FL.

Rich Weese · Answer

Vikram- my process for comparison will work in any state. You can get an easy to compare #, if you compare REAL rental rates, prices and taxes of properties in each state. Rich

R Sean · Answer

Your approach works if you assume rents are equal, which comparing class A California MF vs. TX class A MF, there is up to a 50% difference.

Looked at another way Vikram: if NOI is correspondingly lower, so will the value of the asset, keeping the yield unchanged.  10% on a $1000 NOI is the same yield as 10% on a $800 NOI, but each yields very different asset values.

Values are driven by a multitude of factors: supply constraints, land values, SF home affordability, interest rates, capital markets, blah, blah....which impact the going in yield (cap rate) of a propsective investment.

Vikram C. · Answer

That's great, Rich.  For others who are wondering where to go next, here's the link to the new thread that Rich has started.

http://www.biggerpockets.com/forums/48/topics/39534-any-way-to-compare-real-estate-from-different-states-

Rich Weese · Answer

I just started a new thread discussing just the process to compare different areas, that I START with. Only a starting point. SO many variables. Rich.

Will Barnard · Answer

Rich,

Just got back from TX last night. I assume you are back as well.
I have been told that we can expect quite a few upcoming in the next few weeks. Lets talk via phone soon to discuss further.

Vikram C. · Answer

Rich, I was not trying to compare TX to CA.  That one's a no-brainer.  I was trying to compare TX to other cheap states such as AZ.  More precisely, I was trying to figure out a proper way to account for the tax differential.  TX might still be the best game in town.  But I think we need to come to that conclusion after accounting for the huge tax effect.

Roman, it is not captured in the NOI figures.  The NOI assumption of 50% is a general assumption.  But if one state is going to have 10% of GSI as an extra tax, then that state's NOI will be correspondingly lower.

Will Barnard · Answer

You are right that property taxes are higher and no state income tax has no bearing on us out of state investors. That stated, taxes may be higher, but other costs are lower. All in all, it balances out.
The key factor about TX is the affordability levels.
You just cant find too many deals in double digit cap rates in CA where the taxes are lower (property tax), but in TX, I would not buy at anything under that.

TX offers the ability to get into properties with much lower per door costs, offers lower expenses on many other items like repairs, maintenance, servic eproviders, etc. It is one of the states where you can be cash flow positive, even with full debt leverage.

R Sean · Answer

RE taxes are an operating expense and thus included in your NOI figure.  Your 10% yield captures the tax effect. Stated simply, using your numbers, you are buying an after (property level) tax yield.

No need to figure in differentials.

R Sean

Vikram C. · Answer

Will, I do not dispute that.  I am sure it is still one of the best states to invest in.  But wouldn't you agree that when you compare states with similar costs but very different taxes, you need to account for it in your return calculations?

Is Texas as cheap as it seems?

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