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Sacramento Not on List of Best Markets for SFR Rentals - WTF?!?
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
"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.:
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? ;-)
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well said and written. Quality share. Thank you
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Great perspective Wes, enjoyed the post.
You mentioned the price to purchase one home:
- California's Median Home Price: $490,100
- Kansas City, MO's Median Home Price: $118,400
but you didn't mention investing the same amount of money. You are comparing a 120k investment to 500k. I live in California and actually invest in KC for the low entry level price point and the larger cash flow percentage. Like you stated CA appreciation is through the roof but it is not guaranteed, which is why I prefer to invest for cash flow now over "maybe" appreciation later. I also plan on buying and holding, never selling.
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Wes Blackwell
That is great if you have the money, credit, and resources to buy a $500,000 property. For the grand majority of the US population, that just is not possible.
A $120,000 property is in the realm of possibility for many more people. That is why many who live in California invest out of state.
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Well written post @Wes Blackwell, I can attest to this very thing happening in Sacramento. 2 years ago I bought a SFR at 130k in Sacramento dropped ~40k in fixing it up and now said house is worth ~230k.
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Good point. I didn't mean for this post to put off people from investing out of state (which I think is a great idea for the investor if they can make it work), but just to point out the error in the provocative headline suggesting that Sacramento isn't a good place to invest for rentals.
I'm a big believer in "invest where you know... or can easily drive to." It makes it SO much easier for the beginning investor if they already know the area or can get familiar with it very quickly. Investing out of state brings the added obstacle of distance and unfamiliarity into the already complex equation. We've all heard horror stories of turn-key companies selling some poor sap up the river because they lied about the neighborhood or work being done, and in an absolute worst-case scenario, you can't always just hop on a plane and fly out there for a week to fix things.
But, if you know the out-of-state market well, or have family and friends in the area that can act as boots on the ground should you ever need them, I think investing out of state is a fabulous idea. Just don't do it using the same metrics and analysis as you'd use for California, and vice-versa.
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Entertaining read @Wes Blackwell! You're a good storyteller and I appreciate your view on cashflow vs. appreciation even if it wasn't a dollar for dollar example.
When you organize the march against universal basic income, let me know, I'm in. Same concept as rent control...fraught with unintended consequences.
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Great post, but I have to point out that appreciation cannot outpace inflation and income growth forever. That is my main concern investing in California right now as a buy and hold investor. The higher prices go relative to general inflation and income growth, the farther they can fall in a bad economic environment. Of course, prices could keep rising for several more years as well. The unpredictability of appreciation make it something I can't invest in by itself. A property needs to cash flow, that is my baseline income and will protect me during a downturn. Right now, too many properties in CA have negative cash flow. I don't like gambling, I only like to make bets I can win.
2 year later I still feel the same way. It seems like everyone and their mother says don't invest in CA but someones got to :) I don't expect appreciation to continue at the rate is has the past 2 years but I do expect to be able to take out more equity from the home in the future.
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CA is an appreciation market, at least most of it and throughout most of the time. It used to be that Sac, Fresno, Bakersfield could produce reasonable cash-flows, but not anymore. Sac in particular has skyrocketed due to Bay Area exodus. So trying to get a good cash on cash returns there is almost impossible unless you get lucky and snatch an occasional deal - most opportunities are in flips. you can still get 5% cap on smaller MFRs - compared to Bay Area's 2% that's obviously much better, but if you're after cashflow than midwest and parts of south are better bets
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@Wes Blackwell thanks for posting this. I like the details. What are your thoughts on recessions in the appreciation equation?
I agree that we should look at a combined version of appreciation and cash flow to determine the best places to invest, however, if that appreciation gets taken out or lowered somehow then what would our returns look like?
I understand that you are looking at long term (10, 20, 30+ years) however, if we go into another recessionary cycle, do you think it will matter?
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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 ;-)
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@Wes Blackwell thanks for your posts (this one and others on Sac and AZ). Appreciate your perspective. How do you anticipate the virus, stock market down turn, and sudden recession will affect SFR pricing in Sacramento over the next 6-12 months? Love to hear your thoughts.
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@Wes Blackwell - Agreed. I'd love to hear your thoughts as well.
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Here is some of a post I made in a similar topic about the Phoenix market specifically (I am licensed in CA and AZ and work in both markets).
***
Real Estate in CA is different than other states right now, because CA shut down basically all real estate activity, while AZ considered Real Estate an essential service, so there's it hasn't been nearly as affected.
Ultimately yes, it virus will have some impact, but it's not like housing demand suddenly disappears overnight.
One of my agents did couple open houses last weekend and have 5-6 people through a day like it was nothing. Other realtors are reporting multiple offers, no slowdown in sales, etc. on various message boards and Facebook groups.
Where I think it will impact housing the most is in the higher luxury price ranges, as those buyers and sellers are usually business owners and have a lot of their net worth tied up in other assets more affected by the virus and it's impact on the economy.
But bread and butter homes sub $300k? That market is practically bullet proof here, simply too much demand. Buyers still need to move for their jobs, be out of their old place by the end of the month, and so on. And sellers still need to sell. So not much has changed really.
Now, that all being said, it's still too early to see what the long term affects will be, mostly based on how soon things can return back to normal.
I think that when the Coronavirus hysteria is over (hopefully within a few months), everything will get back to normal and you'll see some pent up demand unleashed in the summer & fall.
But we'll have to wait and see... I think it's important to keep your finger on the pulse and re-evaluate the market on a week-by-week basis.
Excellent thread. I'm looking to invest $450-$500 NOW for a 1031 exchange. Like everyone else, I'd like a place that cash flows positive and appreciates. Or at least not lose my initial capitol investment or better, to have at least some equity two years from now. Its anyone's guess this point in the Covid crisis where the market will be, but I figure if I can buy a place at 10% below market, then I have some buffer. Personally, I think the market will be down. With unemployment up and likely to rise, and the global economy sinking, seems like not much to support pre-Covid market and less for an upward market. For now, the only thing certain is uncertainty.
As for markets I'm checking out, Sacramento area and Orange County are on list.
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I don't know what impact COVID-19 will ultimately have on the property market in Sac, particularly in the short term, say next 12 to 24 months. Long term, it seems the general macro trend will prevail with Sac continuing to grow and with population growth we will see price appreciations as well
However, Sac prices also have run up quite a lot over the last 3 years and both buyers and sellers are fretting. I myself pulled a plug on an investment property that I would have closed prior to shelter in order. At the same time, I had 2 different sellers call me to ask if I wanted to re-bid on duplexes I lost out to bidding wars - in both cases buyers backed out, with one of them having 2 of his buyers backing out. So yea, I would not be surprised we will see price declines of 20%-30% in the coming 12 to 24 mo