Originally posted by Dean Letfus:
QUOTE:
"The problem with Memphis that I'm assuming package providers in general don't tell outsiders (no offense to anyone) is that most newer Memphis neighborhoods have a life span of about 10 years before they turn into Class C. Cordova is perfect example. Germantown Parkway 10 years ago was booming and now the retail vacancy rate is about 25%. Before that was Hickory Hill, nice 20 years ago and 10 years later a war zone. The exception is the older and established zip codes -- 38117, 38120, etc but these are much more expensive and have low caps."
This is not true of Memphis from an investment point of view. What you are saying is that these areas have gone from white to black. HOwever many of them are now wealthy black or high rental level black suburbs so fabulous for investors. Hickory Hill is a good example. There are a few streets that are really rough but large parts of Hickory Hill are completely stable and rents are $800 to $1100 a month. We buy in there from the low 40's and can never get enough inventory.
If you bought in parts of Cordova when they were selling for low to mid 100's then you would be in trouble but same story there now. Buy in the right parts and you can be all in for 50 to 85K and rents are $900 to $1250.
I do not dispute that you can buy 'really good deals' and make money, but if you buy at or near FMV, you should not realistically expect any substantial price appreciation from most Memphis neighborhoods. I also do not believe that you can find 'really good deals' on any sort of scale (more than 5-10 houses per month).
Thus, what I said still applies. Hickory Hill was brand new B+ neighborhood 20 years ago and is now a class C neighborhood in terms of crime AND property values, regardless of race. Property values did not keep pace with inflation for residential. For commercial, they were a tremendous loss (e.g. Hickory Ridge Mall, various apartment complexes).
If you disagree, please prove me wrong by showing me Hickory Hill examples over a 10 year period where *fair market values* (i.e., not a super deal 10 years ago vs a FVM sale today) increased at a rate at least equal to inflation. Please do the same for Cordova.
You might be able to get 10-12% rental yield in your example, but that will be offset by greater than average capex expenses over your hold time and greater unit turn expenses on a declining or horizontal asset, which is true of all poorer areas no matter the city or the racial demographic. Your example of $40k Hickory Hill houses will earn you a good yield on paper, but your operating expenses over a 10 year hold period will probably be around 65-70% on average for a large portfolio (i.e. not if you get lucky with a small # of houses with really good tenants).
Let's use a realistic hypothetical example :)
- Hold Period: 10 years
- Purchase price with closing costs: $45k
- Make ready improvements: $5k
- Total cost basis: $50k
- Value: $75k
- Average rent over hold period: $1,031/mo*
- Avg expenses before capex: $400/mo**
- EBITDA for hold period: $75k
- Value 10 years later: $90k (2% compounded, about historical average for Hickory Hill)
So, you made about $75k off of your $50k investment before you go to sell the house. This is a little over 11% compounded.
But then there's capex.. You had six turns during this period that cost $3k each because they trashed the carpet and ruined some walls, you need a new roof and perhaps a new AC. There goes another $10k. And then the kitchen is terrible with the cabinets rotting, that's another $5k. Don't forget the bathrooms, $7k. 10 years later, you might need some paint, this is another $5k, etc. Basically $40k to $50k on capex. We'll be optimistic and assume it's only $40k.
When you go to sell:
- Sale price: $90k
- Closing costs: -$4k
- Cost basis before capex: $50k
- Cost basis after capex: $90k
- Net gain/loss: -$4k
- Total gross earnings over holding period: $71k before taxes
- Tax: -$17k (optimistic 25% tax rate)
- Net earnings: $54k
So you have $54k in earnings on your $50k investment over 10 years (that's 9% compounded). This isn't a lot of room -- what if you get a couple of nightmare tenants that completely ruin your house? It's not unrealistic for capex to cost you $60-80k over the hold period. What if values stay exactly the same over the time period? This isn't unrealistic either. Look at Fox Meadows, just west of Hickory Hill. Is it worth the risk of no appreciation or huge unforeseen capex expenses for a forecasted 9% annual return? You can do rosy assumptions -- 3-4% appreciation, 50% expense including capex, etc. but rosy assumptions are only good for pro formas where you're trying to flip your package to newbs.
Run some numbers using FMV as your cost basis instead of a 'great deal' discount and where are you left? It's not too pretty. Sure, you could juice things with leverage and do 'ok' but 1) it's harder to find banks that will lend on older properties and 2) loans with small valuations are costly on a percentage basis, and with a loan on a very cheap SFR, the property doesn't earn enough income to justify the time - do you want to run all over town for $100 per unit?
** This is rental growth compounded at 3% over the hold period
*** Expense growth compounded at 3% over the hold period
