Is the hot air finally leaking out of the balloon?

Question

As the saying goes, what goes up, must come down. I’ve noticed houses are staying on the market longer and longer, and prices are being reduced in response. Does this mean the boom is over and we should be preparing for the bust? As a neophyte REI, I’m quite trepidation about jumping in with both feet, full force, hoping for the best. Any long term investors see a familiar cycle right now?

Lisa Flynn · Answer

I do believe that this is a time where real estate is truly "local". You may be seeing things slow down in CA but here in SW Florida there is absolutely no sign of slowing. There may be some pockets (such as your area in CA) that are showing a pull back. But here we are still in bidding wars, most buyers are cash, prices continue to climb and there is no sign that is going to change anytime soon. Truth be told, many of these cash buyers are coming from places like CA and NY...
We do have some price reductions. But that is mostly from sellers really trying to push the market. When they come to their senses they do adjust the price to fit the, still very strong, seller's market.

Dan H. · Answer

This method has worked for the last ~10 years (I have done fairly well doing mostly BRRRR in the last 9 years), but at some point the properties will level off or maybe even have some price erosion.  That would not be very bad except that currently MLS listed properties typically are initially cash flow negative.  And, if using realistic expense projections, are typically significantly cash flow negative (check expense projections against the 50% rule).

it reminds me of musical chairs, someone will eventually end up without a seat.

The problem, just like in musical chairs, is knowing when the music is going to stop.  I do not claim to know, but I am so adverse to purchasing cash flow negative that I have only purchased one property recently.  In hindsight, I wish I purchased a dozen.  It does not mean that it is currently a good idea to purchase a dozen properties.

Good luck

Patrick Drury · Answer

@Amy Hatcher

You should look to invest OOS. A lot of investors in California right now are looking to other cities where the price point makes sense like Columbus OH. As long as you have what David Greene calls your core 4 you should be in good shape. They are a lender, realtor, contractor, and property manager.

Lisa Flynn · Answer

Hang in there and keep it up!  There are still deals to be had and its a good time to just learn whatever you can to prepare for the future!

Amy Hatcher · Answer

Thanks all. This is part of my frustration, not being able to invest in my own home town. My own neighborhood has gone up 24% since January, making it impossible for “the little guy” to get in and actually make a difference close to home. I’ve been looking at other areas of course, and have noticed a cooling off in several of them. Which is good, and bad. Of course, no one want a to buy at the peak and get stuck there, which is a genuine concern with the craziness that we’ve witnessed in the past year or so. I’d love to not only be a super successful REI, but also bring new life and pride to neighborhoods needing a little facelift. Good for them, and good for me. Any suggestions?

Dan H. · Answer

In the San Diego market, the average property has an initial rent to purchase ratio below 0.5%.  I suspect most investment properties are hitting a 0.6% ratio.  I think the investors with a lot of contacts and good reputation (or those that happen to find good deals) are hitting a 0.7% ratio.  A few of the best connected (typically off market purchases) are hitting above 0.8% ratio.  A 1% ratio is a unicorn find in San Diego (they do happen but they are real rare - I know of one in the last year).

Note a keyword is initial.  Everyone of our properties now meets the 1% rule.  One has over a 4% rent to purchase ratio.  In addition, our lowest appreciating property (the worst of the bunch) has appreciated over $1900/month over the hold period.  We have 3 properties that have appreciated over $4k/month over the hold period.  Question is, how long will the appreciation trend continue?  It has been ~10 years of good appreciation in San Diego.  It will slow down at some point.

As for your math, it ignores all expenses.  In historical zero appreciation markets (markets that historically appreciate slower than the rate of inflation like much of Ohio), the 50% rule is aggressive.  This implies that without including the loan costs, the 1% property is already returning less than 6% of the property cost per year.  If financed, the loan payments need to be subtracted which at 3%, 30 year is an over an additional 4% of the home value annually (but there is some equity paydown).  Sum total using 50% rule (going optimistic and stating 50% rule is realistic which it likely is not in zero appreciation markets without a very active role) if financed at 3%, 30 years is a whopping <2% of the property value per year.  In 2 years, the finance property has about 4% of property value in cash flow.  If the property depreciated 20%, you would be ~16% negative after accounting for the cash flow (but not counting equity paydown which is ~2%/year).

You may think 50% rule is conservative or not accurate and I admit that its accuracy varies by market.  However, in general, it is aggressive in the zero appreciation markets without the LL taking a real active role (acting as PM, handyman, etc. reduces the expenses).

Good luck

Maxwell Ventura · Answer

@Amy Hatcher

If you don't have the 20-25% capital for an investment property out here maybe try partnering up with 1 or more people OR go owner occupied w/ little $$ down. Plan to refi out in a year or two and keep accumulating properties while paying down debt and taking advantage of appreciation & additional tax savings

Twana Rasoul · Answer

@Amy Hatcher the only properties in San Diego that are staying on the market a long time are the ones that are either way over priced or something is wrong with the property itself.

Amy Hatcher · Answer

@Patrick E. Blankenship

I’m absolutely willing and able to partner up with people, and would actually prefer getting a great team together. Having different strengths from each member makes the team that much more effective.

Is the hot air finally leaking out of the balloon?

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