Sacramento Not on List of Best Markets for SFR Rentals - WTF?!?

[Wes Blackwell]

While reading over the local real estate news this morning, I stumbled across a headline that made me do a double-take and drop my spoon into my bowl of delicious honey nut cheerios:

Sacramento Not On List Of Best Markets For Buying Single Family Rentals

http://www.capradio.org/articles/2017/03/23/sacramento-not-on-list-of-best-markets-for-buying-single-family-rentals/

"Sacramento is not the most lucrative real estate market for people who want to get into the landlord business.

If you want to buy a single-family rental, you'll get the highest annual return in places like Atlanta, Baltimore City, and Pittsburgh. But not in Sacramento.

"Well if you're buying in Sacramento, the average return, if you're buying this year, is going to be below the national average," says Daren Blomquist with the research firm ATTOM Data Solutions.

He says the national average is 9%. In Sacramento, it's only 6.4%. That's because median sale prices for single family homes are rising faster than average fair market rents. (Remember this part in bold as you read the rest of this post).

"The rents are increasing but at a slower pace than prices are increasing which means the yields on those rental properties are coming down and not as attractive in a market like Sacramento," says Blomquist.

.........................

Now, here is a prime example of someone who doesn't understand California real estate.

And here's why:

Real estate investing really all boils down to 2 key metrics: Cash Flow and Appreciation.

When most investors think real estate investing, they think cash flow. The thought process is essentially as such:

"If I buy this property at the right price, and rent it for the right amount, I'll get some cash every month after paying all my expenses. Sweet! Can't wait to quit my day job!!!" <-- *eyeroll*

But most investors don't really think about the appreciation. Why is that?

Well, if you ask me, it's because humans are extremely short sighted. You may have forgotten your history lessons, but just a short time ago humans were only living to be roughly 30 years old. That means just about everyone reading this post would've already been dead by now.

Back in the caveman days, if you stumbled across a gazelle trotting along the plains of Africa, you killed it and ate it ASAP. And that's probably because you hadn't eaten in forever, and weren't sure when you'd be able to again. So the need for IMMEDIACY is hard-wired into our programs. 

(If you ever want to see just how bad humans are at impulse control and thinking long term, just google "Stanford Marshmallow Experiment": https://www.youtube.com/watch?v=QX_oy9614HQ)

Cash flow is immediate. You can even get a rough calculation for it before you buy the property. So you see it up-front, and within 1 month you will start to see your returns. The need for immediacy is satiated and satisfied.

But what about appreciation? Well sheesh, that takes years!!! Ain't nobody got time for that! Even worse, it's not guaranteed! "Pure speculation" you say, and only need to point back to the early 2000's to see where that type of investing got us.

But here's the thing... real estate cycles go up and down. Always have, always will. And now that you're on BP you should know this by now. Here's some proof for you skeptical fellows:

• https://www.cato.org/publications/commentary/great-18year-real-estate-cycle
• http://www.theepochtimes.com/n3/2000510-economists-explain-why-our-economy-crashes-every-18-years/

California is all about buy low and sell high, more than just about any other market in the U.S. And that's because California is completely different than just about every other market in the U.S. Take a looksie here at a heat map of home prices across the U.S.:

• https://www.trulia.com/home_prices/

Notice something about that area all the way over on the left side of the country? Quite expensive now isn't it? But you already know that, I didn't need to tell you.

But, you probably didn't realize just how cheap the rest of the country is, did you? I mean, just LOOK at how much of that map is green!!! Cheap, cheap properties as far as the eye can see!

If you're a boomer thinking about retiring and selling your California home to move somewhere out of state that's more affordable, here's a comparison to get you motivated:

• California's Median Home Price: $490,100
• Kansas City, MO's Median Home Price: $118,400

That's make California nearly 4 times as expensive! YIKES!!!

But, here is where most investors go wrong in their thinking:

"California is 4 times as expensive as Kansas City... do I get 4 times the cash flow? NOPE = California is a bad investment."

But here's what they should be thinking:

"California is 4 times as expensive as Kansas City... do I get 4 times the appreciation? YEP = California is a GREAT investment."

Allow me to explain:

Let's just say that both areas get 7% appreciation next year. Let's do the math:

• California's Increase in Value: $490,100 x 7% = $34,307
• Kansas City's Increase in Value: $118,400 x 7% = $8,288

So, let's say you bought out in Kansas City and got $1,000 per month cash flow, and I bought here in California and just broke even. Who made a larger gain at the end of the year?

• California: $34,307
• Kansas City: $20,288
• $34,307 - $20,288 = $14,019+ California for the win!

Now run that calculation out like 3-5 years... and now who is REALLY ahead? If we buy and sell at the same time in those markets, at the end of 5 years I will have realized $70k more than you!

Plus, even if neither property appreciates and we make the same cash flow over 30 years, once it's paid off the one in California will easily rent for 2-4 times as much, so the Golden State wins again!

And that's what this guy missed in his article. It cracks me up because he even directly brought up home values increasing, but didn't even address it!:

"...median sale prices for single family homes are rising faster than average fair market rents."

Also, this guy must've missed the news that Sacramento rents went up over 11% last year, are projected to go up 10% this year, and 8.5% next year. Meanwhile appreciation is projected at 7.2%. So his statement isn't even correct to begin with.

But here's the thing folks... rental property should really be about retirement. The days of working 40 years for the same company and getting the gold watch when you retire are GONE. Long gone.

Robots are coming for your jobs... they're even coming for your boyfriends... and universal basic income is inevitable... so wouldn't it be nice to have a nice rental property 30 years from now to provide housing to those jobless, mateless souls who can pay you direct deposit from their universal basic income check? :-)

Sorry to get all dreary there at the end with humanity's bleak future... I know it's not something we like to think about it, but perhaps we should. 

Long term, remember? ;-)

[Wes Blackwell]

@Sanjeev Advani

Hey Sanjeev! Great question. Here are my thoughts on Sacramento long term:

First and foremost, the thing that is STILL driving demand in Sacramento 2 years later after writing this post is all of the migration from the Bay Area. People are fleeing in droves for more affordable housing, and the Central Valley (Yuba, Sacramento, Stockton, Modesto) is the last place to find it. 

Just look at the map below of SFR priced $250k or lower:

This pattern was originally predicted to continue through 2020, and doesn't seem to be slowing down. Just listed a $275k home in Stockton and got 3 offers the first weekend, one being all cash... and two being Bay Area buyers.

Sacramento offers the big city feel without the big city price. People from the Bay Area could move to Modesto or Merced and get even lower prices... but no one from an area with a population of 7 million is going to move to a cow town out in the boonies with 83,000 people.

Those that can afford to move to Sacramento will, and those that are on a limited budget and need more inventory will head to Stockton. Where else are they going to find homes at those prices?

Further, Sacramento is a 2 hour drive up 80, which makes it super easy to get back on the weekends to see family, friends, a baseball game, etc. 

I'm getting tons of tech employees at big companies in the Bay messaging me and saying they've got an annual salary of $200k per year and can work remotely, and don't see any reason to pay $15 for a cocktail in San Francisco. You can get the entire entree out here for that.

Longer term, if California doesn't bankrupt itself trying to give citizens of other countries free health care or provide cell phones to the homeless, and actually makes the vision of the California High Speed Rail a reality, or self-driving cars become mainstream and allow commuters to work on the road to work, then Sacramento will absolutely fricking explode with Bay Area commuters.

But then again, we may have FAR bigger problems on the horizon, with automation, robots and AI set to replace as much as 73 million jobs by 2030. That's almost 20% of the workforce. And 47% of ALL jobs are projected to be replaced by 2034.

Winter is coming... and it's not white walkers or climate control... it's automation. What a helluva time to be alive. 

As for recessions, hard to predict timing and impact. We won't have a 2008 repeat for quite some time though, because underwriting is far more strict than ever before. So it's not like if you invest now your property is suddenly going to be worth 50% of the purchase value in 5 years.

But then again, maybe North Korea nukes us. I say that in jest, but want to emphasize the point that nobody has a crystal ball, and anything can happen, and while it looks like Trump will landslide in 2020... you can expect an absolute blood bath in 2024. Who knows what will happen and how policies and economies will change by then.

But for now, Sacramento is getting immigrants and Bay Area transplants by the boatload:

"If you look at our population growth, we need about 200,000 housing units to be built every year just to keep up with the growth. In 2017 we only built 113,00." -- Click to watch vid

15,000 to 18,000 new jobs paying in the $90k range over the next two years. HELLO!

So, do I think a recession will matter. No. But there's no telling what can happen. We'll see how well this post ages, as the original post from two years ago aged quite nicely ;-)