All Forum Posts by: Dan H.
Dan H. has started 31 posts and replied 6368 times.
Post: Housing Questions for Newlywed Young Couple
- Investor
- Poway, CA
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my market is San Diego. It is not far from riverside but our price point is more extreme. in extreme price markets, young people need every hack they can get to afford to purchase a property.
A few years ago a conventional 95% OO loan option was added. Unless you absolutely have no way to cover the 1.5% LTV gap, I suggest you use the 95% LTV OO over the 96.5% LTV FHA. This is especially true if buying more than 2 units or purchasing units that need some TLC. Understand the fha PMI versus tradition pmi rules.
Rent to own works great when property values are increasing. It locks in a value. We are current in a lull in appreciation in So Cal. No idea when the lull will end. If prices are not increasing, rent to own benefits the seller.
Typically if you go rent to own, you will have lower than 96.5% LTV. I believe it is unlikely FHA will be your best financing option. Maybe the seller will offer financing.
I recommend young people reduce rent to save for a home purchase. Living with family is likely the best choice if it is an option. Sometimes it is difficult to live with family and is time to fly the coop. The lowest rent point besides staying with family is typically achieved by roommate quantity. A 4 br unit typically has much cheaper rent than two 2 br units. Of course you have to share the common areas with more people.
Many LL charge a premium for leases significantly less than a year. Saving takes time. I suggest you do not pay a premium rent for a more flexible lease duration.
You did not ask about income. It is important to optimize income. It is necessary to qualify for any loan OT (not taxed for the next few years), side hustles (tips not taxed for the next few years), maximizing raises by committing to your best performance, etc. you sacrafice when young to improve your life forever.
You mentioned FHA. It has some short-comings. However, financing is important. I already discussed conventional 95% LTV. There are other options. Look into NACA. I cannot emphasize this enough for your situation. Other options are assumable and owner financing. The most common require OO. FHA and VA ( VA can be assumed by a non military OO). All options require an income that shows you can safely make the payments. It is why maximizing income is important.
Good luck
Post: WOULD YOU INVEST IN HOUSE with back yard is backed to the major freeway?
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- Poway, CA
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Quote from @Katie Nguyen:
Hello to all beautiful mind investors within BP community,
I am thinking of buying a large single home family with lots approved for ADU located in a great city in California for a great deal. Could you please share with me your thought on this investment particularly I would like to know what are the investor/landlord's Liability risks when Renting out the property for Section 8 vs Short-term rental. My 1st investment, should I hire a management company or do it myself with one on one expert consultant fee. Any advice, share of ideas and thought are greatly appreciated.
Best,
Katie
I have multiple STRs in San Diego. 2 are in Pt Loma, pt Loma is a high b, maybe low A area. I suspect median Home price approaches $2m. Pt Loma is in the usual Lindbergh field flight path. All areas in Pt Loma can experience flight noise. In the anrea, the pause in conversation due to plane noise is called the OB or Pt Loma pause. People live with it. Our STR listings make clear that there is airplane noise. There is no way to know how the disclosure affects the rent we get or our occupancy.
What I do know is that even though it is clearly disclosed, we have got multiple reviews that indicated their dislike of the airplane noise. If the guest wants to stay in pt Loma or OB, they will almost for sure need to deal with airplane noise.
I would be leery of purchasing for STR a property that backs to a major freeway. Unlike my market, there will be STRs that do not have the same negative item. You will have to beat them on price to tempt guests to risk staying in a unit that backs to a freeway.
Many years ago after I had already been in RE for many years a friend purchased a property that he indicated was below market to be his OO home. When I went to it, it was right above a major freeway. His comps were not. The discount reflected the discount for being above the freeway. I did not tell him, but did tell my wife as soon as we left. He later spent more than the discount off comps in an attempt to reduce the noise. It helped significantly, but not completely.
Good luck
Post: How Important Is Cash Flow When You're Just Starting Out in Real Estate?
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- Poway, CA
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Quote from @Peter W.:
More than anything it depends on your personal finance situation. The second thing is the market. In the HCOL, there are properties that negative cash flow 1k/ mo that would likely let you retire in 5-10 yeas. I was trying to convince someone to house hack in NYC on another post. At 5% down on a 1m dollar house hack, you would lose 1k-1.5k a month compared to market rent, but would, conservatively, gain 50k+ a year on home equity. By year 3 or 4 you would be cash flow neutral. Repeat the process twice and you'd be able to retire by year 10.
I expect my properties to be at least cash flow neutral. However, if I lived and invested in Washington DC, NYC, Boston, SF and maybe, but probably not, Seattle, LA, Philadelphia and San Diego I would consider negative cash flow properties. I would expect my principle paydown part of PITI to be on par with my negative cash flow.
Neighborhoodscout appreciation for this century. Note this century includes the biggest housing value decline in us history (GFC):
- Washington DC: 6.23%
- nyc:: 5.32%
- Boston: 5.05%
- San Fran: 4.13%. work from home has not been kind to SF appreciation Prior to work from home SF was very high on this list.
- Seattle: 5.15%
- LA: 6.31%
- Philadelphia: 5.61%
- San Diego: 5.74%
the only city not ranked 10/10 for appreciation this century is San Francisco. Historically it has been high on the list of highest appreciation cities but lost ground with the work from home movement.
https://www.neighborhoodscout.com/dc/washington/real-estate
https://www.neighborhoodscout.com/ny/new-york/real-estate
https://www.neighborhoodscout.com/ma/boston/real-estate
https://www.neighborhoodscout.com/ca/san-francisco/real-esta...
https://www.neighborhoodscout.com/wa/seattle/real-estate
https://www.neighborhoodscout.com/ca/los-angeles/real-estate
https://www.neighborhoodscout.com/pa/philadelphia/real-estat...
Post: Why markets with low appreciation grow your net worth twice as fast
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- Poway, CA
- Posts 6,493
- Votes 7,549
Quote from @Mike D.:
Quote from @Dan H.:
Quote from @Mike D.:
Quote from @Dan H.:
Quote from @Mike D.:
Quote from @Dan H.:
Case Shiller used to publish a list with total residential return for this century. The top of the list was all high appreciation markets. The bottom of the list was comprised of high initial cash flow properties. What the list showed was a strong correlation between appreciation and cash flow over a long hold. The list showed a poor correlation between long term cash flow and initial cash flow.
I invite you to run your numbers at 80% LTV using that extra down payment to deal with any initial negative cash flow. Use the appreciation and rent growth for this century on each city. Basically the case shiller data without the effort of determining local property tax, maintenance, PM rates, etc..
In have been investing in my San Diego market for many years. I have purchased with poor timing and great timing. My worse appreciating property has appreciated $2700/month over its hold ($47k down and closing). My best appreciating properties have appreciated over $10k/month over their hold. I suspect that virtually all residential RE in my market will have numbers between my best and worse case.
Knowing the San Diego appreciation rate (almost 6%/year for this century per neighborhoodscout) how do you think the rent growth has been?
With time the market with the higher rent growth will always have higher cash flow than the higher initial cash flow market that has lower rent growth. It is basic math,
So the high appreciation market has historically produced both better appreciation numbers and better long term cash flow than the low value markets. This is easy to verify and I believe most experienced investors ecognize this. I recognize past history is not necessarily an indicator of future performance but the metrics on my San Diego market still look promising.
My view is the low cost markets are best served by local RE investors who know the nuances of the area.
Best wishes
Okay, running the numbers at 80% LTV sounds interesting. If you do it for Austin, leaving all the other numbers from the initial example the same, you'd have a $2129 monthly payment on a 30 year loan with 7% interest, so -$14,296 negative cashflow. Since you are capturing the full appreciation on the property with a lower down payment, $80k, and since you now have larger principal paydown ($3251 in the first year), your return is now: cashflow -$14,296, principal paydown $3251, appreciation $28,000 = $16,955/$80,000 = 21.2% return. So far it looks good. So far.
And yes, you could now stick a very large amount of money in reserves to deal with the negative cashflow. Not sure what kind of rent growth you're proposing but let's say 5%. I used a spreadsheet that I had whipped up previously to figure out how much total you're going to need in reserves before the property starts cashflowing and was surprised to find that it still wouldn't be cashflowing after 20 years (!) and over those 20 years it would incur negative cashflow of more than $217k. The rest of the down payment you were going to put away in my example is only $145k, but that money grows at some kind of rate over the years so I suppose it would end up being enough to make up for all the negative cashflow this property would ever incur.
Even so, several large issues:
- The opportunity cost on the $145k is major. Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
- By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
- You are burdening yourself with negative cashflow for years when you could be in a different market with a higher return making cashflow which you can actually use to go to the grocery store and eat.
- Returns from appreciation are more volatile than cashflow in general and after going through this torture for years it is possible you could see very little payoff.
So, I don't see why someone would do this. I don't have access to the Case Shiller data you mentioned so I made some other assumptions that might be different. I'd also be interested in hearing if I misinterpreted something about what your idea was.
I agree with the thesis that high appreciation markets will eventually produce "better" (at least higher) long term cashflow because rent grows faster as well, but it takes a very long time and comes at the cost of low return on equity, to the point that you'd be better off selling out and going into other investments such as a stock/bond portfolio. You also have to consider the opportunity cost in the years when you're waiting for the cashflow to materialize.
I do not know if you switched numbers from your OP or if your calculation on time span to positive cash flow is off.
You show a negative $328/month on $2200 rent.
Without compounding (with compounding it would be better and take less time to achieve positive cash flow) using your rent growth percentage
1.05 ** years * $2200 - $2200 is the rent
at 5 years
1.05 ** 5 * $2200 - $2200 = $607.82 which is likely enough greater $328 to compensate for expenses other than P&i having risen (basically inflation on the non fixed costs).
>Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
There are many ways to manage risk. I believe high diversification reduces risk. I think only a very conservative investor would have more than a year of safe, liquid reserves (money market, etc). So your reserve scenario does not match most investor’s approach. I do agree that the reserves should not all be in one asset class; that is too risky. But an investor has a year or so liquid and substantial other investment in other classes besides RE, they have a more robust plan than someone relying solely on cash flow.
>By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
what ends up typically occurring is money is extracted before is gets to a 50% LTV to leverage the capital elsewhere reverting the cash flow. I virtually always have used 30 year fixed loans once stabilized for their safety but I have yet to hold a loan 10 years. With the rate increases that started q2 2022, there is a chance that I will finally hold one of these loans over 10 years.
My worse appreciating property has appreciated $2700/month over its hold. It never had negative cash flow but even if it did, it could not impact the return significantly. I purchased for $47k out of pocket including closing costs. My best appreciating properties have appreciated over $10k/month over their hold. One of these did have initial negative cash flow at purchase (quite large negative cash flow), but in less than 3 years it had positive cash flow. The negative cash flow was always inconsequential compared to the value increase.
I do believe the low cost markets are appropriate for local investors. Long distance investors should seek higher quality assets.
Good luck
Hey Dan, so when you say the cashflow goes positive in the fifth year, something is off there. You must not be using the new P+I for 80% LTV--it's $2129 and there's more than $14k negative cashflow in the first year. So, an extra $608 a month doesn't come close to smoothing that out. Some wires got crossed somewhere.
It seems that a sophisticated, very wealthy operator could possibly implement your strategy--say they had some stream of cash from something else that they didn't need and could funnel into this, removing the need to keep reserves--but for the average person, even the average millionaire, it would be insane. You suggested keeping reserves, but I suspect that if you yourself use this strategy you are doing something different.
I guess I should have said my strategy is not for billionaires!
>Some wires got crossed somewhere.
possibly. In the original post you indicated -$328 cash flow under Austin. Was this not correct? Was it a subset of the cash flow? Maybe there was a typo. It is the number I used.
In San Diego it is common to see projected rent to selling price ratios of ~0.5%. However, these are not typically what is being purchased by investors or if they are it is because they plan on doing a rehab and significantly raising the rent (a value add). The purchases that have those ratios without the value add and a projected rent increase are virtually all OO purchases. I suspect this is the case in virtually all lower cash flow markets. I have never purchased in my market without at least a projected 0.7% stabilized monthly rent ratio, including the cost of value add in the property cost. Since the rates increase, my underwriting shows 0.7% ratio is cash flow negative at high LTV in my market (while being far superior to the rent ratios that would occur on OO purchases).
I question if your large negative cash flow is mostly derived using stats that include OO purchases. I know if this was done on my San Diego market, it would depict a far worse cash flow than the already bad cash flow that investors are obtaining. I find it unlikely that Austin investors are regularly purchasing investment properties that project negative $1,167/month cash flow (even though my last purchase my underwriting showed a little worse than this per unit (4 units), but it had value add and positive cash flow was achieved in less than 3 years).
Do you believe Austin RE investors are buying at a projected negative $1,167/month? I think it is unlikely.
I will also point out that if I purchased in my market a property that was negative $1,167, my worse monthly appreciation property is $2700/month. $2700 - $1167 =$1,533.00 monthly return not including equity paydown and that is my worse monthly appreciating property. My best is up ~$1m in 3.5 years. $1m/40 is $25k/month (by the way it is the same property that had the horrendous cash flow at purchase that I mentioned earlier in this post). Tough to make $25k/month in cash flow with less than 5 units.
by the way my underwriting does not show those cheap markets to have cash flow anywhere near the projections of those investing there. In general the investors grossly under estimate maintenance/cap ex, do not depict anything for PM and sometimes grossly under represent vacancy/uncollected rent. I saw a post recently that showed $86/month maintenance/cap ex and a vacancy rate of one quarter the city’s vacancy rate. The $86 was 10% of rent and is at least a factor of 3 low for sustaining maintenance/cap ex on that unit. I asked where he got the number and got an initial reply that he had calculated it via cost and lifetime. It was clear he used 10%. I called him on it and did not get a response. I asked how he justified using vacancy of 25% of the city’s vacancy rate and got a reply that he was in the suburbs with lower vacancy. I believe he could have lower vacancy, but 75% lower seems unlikely. Certainly it seems to be very aggressive underwriting. I pointed out he had no entry for uncollected rent so his 5% vacancy was covering both. This is the quality of the underwriting I see regularly in low rent markets. This under writing is unlikely to be sustainable over any reasonable length hold.
There are challenges in RE everywhere and I believe those in low cost markets should start there (but in the upper half of the price range of that market). I do not believe these markets are likely to produce the returns that OOS investors seek.
Good luck
Hey Dan, I found the mistake here--the $328 is the *annual* cashflow for Austin. Everything I've written is with that in mind.
I understand that basically what you're saying is that an investor in Austin is unlikely to buy a single family home in that price range. I don't know about the logic of other investors--I've seen people on the board buying houses like that--but that would be my logic as well. So if you want to redo both examples using small multifamily, that's fair, but I think you'll find the same principle applies. Comparing apples to apples, the small multifamily property in Memphis is going to have a much higher rent to selling price ratio than the one in Austin, and I don't think the scale of the return of the Austin property to the Memphis one would change much.
I know that your underwriting shows that investing in cheap markets is very unprofitable--we've discussed that before. On my actual investments, which are small multifamily in the Midwest, I get about $100 a month per unit in maintenance and capex, so a duplex would have about $200 a month. The $86 seems low to me but it's not wildly off. I'm basing this on actual records I keep for my own investments using several years of data. I'm not sure about the way that most people invest because the way most people invest is probably irresponsible, honestly. There are plenty of people who buy junk turnkey properties from lying, cheating providers and lose their shirts.
My point about the investment that's -$1167 a month is this. It's not suitable for most people. If they have to keep reserves, like I said before, it creates way too much idle cash and the overall return on the reserves + the property itself is low, making the investment unattractive. If they have an income stream say from a company that they want to funnel into that to deal with the negative cashflow, okay, sure, that person is at a level where what I'm saying no longer applies.
>Memphis is going to have a much higher rent to selling price ratio than the one in Austin, and I don't think the scale of the return of the Austin property to the Memphis one would change much.
On day 1 yes. The case Shiller data showed over long holds the cash flow to purchase cost was highest in the highest appreciating markets. The BP released data that was much shorter in duration (i believe it was an 8 year span) was showing the trend. For example in the 8 years San Diego went from a poor cash flow at purchase to having a total cash flow somewhere near the middle. The cash flow in those 8 years was near the middle. The appreciation was near the top. A longer time span on that BP data would have shown continuing improvement of the San Diego cash flow. The math shows the higher rent growth market will have the better cash flow with time.
>my actual investments, which are small multifamily in the Midwest, I get about $100 a month per unit in maintenance and capex, so a duplex would have about $200 a month.
Using actuals does not accurately reflect future cap/ex. Large cap ex have long lifespans. How many sewers have you needed to replumb? Kitchens replaced? Roofs replaced? Fences replaced? Etc. Even the electrical and hardscape have a lifespan. I guarantee you did not get this $100/month using lifespan and replacement costs on all items associated with the property (true sustained maintenance/cap ex costs). $86/month (and your $100/month) is way too low if allocating sustained costs. I invite you to create a spreadsheet to determine your sustained costs. In my market we have more costly water heaters (low NOX) and high labor costs. It is $1600 to replace at reasonable cost (some plumbers charge a lot more) which I suspect t is quite a bit more than your market. 1600/10 (my expected lifespan in years)/12 (months in a year). The cap ex on the water heater is $13.34/month in my market. Note including the maintenance it is a little higher as pilot lighting, thermostat coupler replacement, occasionally replace a burner under warranty, an anode replacement, etc. do this on all items including the supplied appliances and yard and you will see $100 is way too low even if that is based on your current actuals.
I believe your cash flow projected numbers are very incorrect because I believe you included all the OO purchases in your average purchase price and only the rentals in your rent points. OO in general are larger and more costly by a wide margin than the average rental. If these OO properties were actually rented, it would drive up the average/median rent. So question is how did you determine the average cost of RE purchase? Am. I correct that it includes all the OO? Then recognize the volume of OO versus investor purchases and OO would skew the numbers further. I suspect virtually no Austin RE investor is purchasing projecting a stabilized $1167/month negative. As indicated, I recently purchased a property that at purchase had large negative cash flow. My stabilized cash flow was slightly positive if rents were flat. I just finished stabilization ~6 months ago. My stabalized rent on my underwriting without any rent growth was just over $15k. With rent growth $17.4k and increasing with each tenant renewal.
I do not believe anyone is using your reserve model (including those without income stream to supplement the negative cash flow) but I will admit some (maybe many) are using a reserve model that may be aggressive. I keep less than 1% of my networth liquid. However I am diversified into 3 very Different asset classes and the stock asset class is diversified within stocks. I have little liquid compared to my RE holdings. I guarantee that I am better able to survive a GFC type event than a very large percentage of RE investors. I recognize not everyone can diversify into 3 different investment categories to diversify risk but they are not keeping liquid reserves that cover all negative cash flow until they achieve positive cash flow. My belief is if they have diversified reserves (not necessarily liquid) to cover no income for a year, they are far better prepared to weather a GFC like event than most RE investments.
The historic data is clear that the high appreciation markets have out performed the cheap markets (the case Shiller data clearly showed this, the BP data was on its way to showing this) . It is why you are getting such push back from experienced investors. The question is what will occur going forward. No one knows but I believe in general the high appreciating markets will continue to out perform the cheap markets.
good luck
Post: Got my first service animal request
- Investor
- Poway, CA
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there are a lot if bogus ESA authorizations. You can purchase them on the internet.
PetScreening.com is a 3rd party site that is supposed to flag known bogus ESA authorizations. It is free for ESAs. I suggest you use it for all tenants regardless if they have animals.
My own belief is that petScreening.com flags a small percentage of bogus ESA authorizations. However, what is more important is if the tenants believe PetSceening.com may catch bogus ESAs.
It is easier for tenants with bogus ESAs to apply for units that do no screening for bogus ESAs. This is especially true if the tenant with the bogus ESA loses their application fee.
good luck
Post: Question on Foreclosure Laws
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- Poway, CA
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Quote from @James McGovern:
Government can make whatever laws it wants. If the second amendment is a constitutional right, nothing stopped them from infringing. Why do we delay the inevitable? @Minna Reid
5th amendment comes into play. 5th amendment also has limits by interpretation of the courts. Eviction moratorium in effect has LL providing housing in some cases without reasonable expectation of compensation (collection of rent). In my jurisdiction, the eviction moratorium was the most extreme in the country. The tenant could break all items in the lease and not pay the rent and they still could not be evicted.
If the lender has foreclosed and previous owner has vacated/evicted, the lender (now owner) can allow viewing the inside.
Post: Why markets with low appreciation grow your net worth twice as fast
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- Poway, CA
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- Votes 7,549
Quote from @Mike D.:
Quote from @Dan H.:
Quote from @Mike D.:
Quote from @Dan H.:
Case Shiller used to publish a list with total residential return for this century. The top of the list was all high appreciation markets. The bottom of the list was comprised of high initial cash flow properties. What the list showed was a strong correlation between appreciation and cash flow over a long hold. The list showed a poor correlation between long term cash flow and initial cash flow.
I invite you to run your numbers at 80% LTV using that extra down payment to deal with any initial negative cash flow. Use the appreciation and rent growth for this century on each city. Basically the case shiller data without the effort of determining local property tax, maintenance, PM rates, etc..
In have been investing in my San Diego market for many years. I have purchased with poor timing and great timing. My worse appreciating property has appreciated $2700/month over its hold ($47k down and closing). My best appreciating properties have appreciated over $10k/month over their hold. I suspect that virtually all residential RE in my market will have numbers between my best and worse case.
Knowing the San Diego appreciation rate (almost 6%/year for this century per neighborhoodscout) how do you think the rent growth has been?
With time the market with the higher rent growth will always have higher cash flow than the higher initial cash flow market that has lower rent growth. It is basic math,
So the high appreciation market has historically produced both better appreciation numbers and better long term cash flow than the low value markets. This is easy to verify and I believe most experienced investors ecognize this. I recognize past history is not necessarily an indicator of future performance but the metrics on my San Diego market still look promising.
My view is the low cost markets are best served by local RE investors who know the nuances of the area.
Best wishes
Okay, running the numbers at 80% LTV sounds interesting. If you do it for Austin, leaving all the other numbers from the initial example the same, you'd have a $2129 monthly payment on a 30 year loan with 7% interest, so -$14,296 negative cashflow. Since you are capturing the full appreciation on the property with a lower down payment, $80k, and since you now have larger principal paydown ($3251 in the first year), your return is now: cashflow -$14,296, principal paydown $3251, appreciation $28,000 = $16,955/$80,000 = 21.2% return. So far it looks good. So far.
And yes, you could now stick a very large amount of money in reserves to deal with the negative cashflow. Not sure what kind of rent growth you're proposing but let's say 5%. I used a spreadsheet that I had whipped up previously to figure out how much total you're going to need in reserves before the property starts cashflowing and was surprised to find that it still wouldn't be cashflowing after 20 years (!) and over those 20 years it would incur negative cashflow of more than $217k. The rest of the down payment you were going to put away in my example is only $145k, but that money grows at some kind of rate over the years so I suppose it would end up being enough to make up for all the negative cashflow this property would ever incur.
Even so, several large issues:
- The opportunity cost on the $145k is major. Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
- By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
- You are burdening yourself with negative cashflow for years when you could be in a different market with a higher return making cashflow which you can actually use to go to the grocery store and eat.
- Returns from appreciation are more volatile than cashflow in general and after going through this torture for years it is possible you could see very little payoff.
So, I don't see why someone would do this. I don't have access to the Case Shiller data you mentioned so I made some other assumptions that might be different. I'd also be interested in hearing if I misinterpreted something about what your idea was.
I agree with the thesis that high appreciation markets will eventually produce "better" (at least higher) long term cashflow because rent grows faster as well, but it takes a very long time and comes at the cost of low return on equity, to the point that you'd be better off selling out and going into other investments such as a stock/bond portfolio. You also have to consider the opportunity cost in the years when you're waiting for the cashflow to materialize.
I do not know if you switched numbers from your OP or if your calculation on time span to positive cash flow is off.
You show a negative $328/month on $2200 rent.
Without compounding (with compounding it would be better and take less time to achieve positive cash flow) using your rent growth percentage
1.05 ** years * $2200 - $2200 is the rent
at 5 years
1.05 ** 5 * $2200 - $2200 = $607.82 which is likely enough greater $328 to compensate for expenses other than P&i having risen (basically inflation on the non fixed costs).
>Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
There are many ways to manage risk. I believe high diversification reduces risk. I think only a very conservative investor would have more than a year of safe, liquid reserves (money market, etc). So your reserve scenario does not match most investor’s approach. I do agree that the reserves should not all be in one asset class; that is too risky. But an investor has a year or so liquid and substantial other investment in other classes besides RE, they have a more robust plan than someone relying solely on cash flow.
>By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
what ends up typically occurring is money is extracted before is gets to a 50% LTV to leverage the capital elsewhere reverting the cash flow. I virtually always have used 30 year fixed loans once stabilized for their safety but I have yet to hold a loan 10 years. With the rate increases that started q2 2022, there is a chance that I will finally hold one of these loans over 10 years.
My worse appreciating property has appreciated $2700/month over its hold. It never had negative cash flow but even if it did, it could not impact the return significantly. I purchased for $47k out of pocket including closing costs. My best appreciating properties have appreciated over $10k/month over their hold. One of these did have initial negative cash flow at purchase (quite large negative cash flow), but in less than 3 years it had positive cash flow. The negative cash flow was always inconsequential compared to the value increase.
I do believe the low cost markets are appropriate for local investors. Long distance investors should seek higher quality assets.
Good luck
Hey Dan, so when you say the cashflow goes positive in the fifth year, something is off there. You must not be using the new P+I for 80% LTV--it's $2129 and there's more than $14k negative cashflow in the first year. So, an extra $608 a month doesn't come close to smoothing that out. Some wires got crossed somewhere.
It seems that a sophisticated, very wealthy operator could possibly implement your strategy--say they had some stream of cash from something else that they didn't need and could funnel into this, removing the need to keep reserves--but for the average person, even the average millionaire, it would be insane. You suggested keeping reserves, but I suspect that if you yourself use this strategy you are doing something different.
I guess I should have said my strategy is not for billionaires!
>Some wires got crossed somewhere.
possibly. In the original post you indicated -$328 cash flow under Austin. Was this not correct? Was it a subset of the cash flow? Maybe there was a typo. It is the number I used.
In San Diego it is common to see projected rent to selling price ratios of ~0.5%. However, these are not typically what is being purchased by investors or if they are it is because they plan on doing a rehab and significantly raising the rent (a value add). The purchases that have those ratios without the value add and a projected rent increase are virtually all OO purchases. I suspect this is the case in virtually all lower cash flow markets. I have never purchased in my market without at least a projected 0.7% stabilized monthly rent ratio, including the cost of value add in the property cost. Since the rates increase, my underwriting shows 0.7% ratio is cash flow negative at high LTV in my market (while being far superior to the rent ratios that would occur on OO purchases).
I question if your large negative cash flow is mostly derived using stats that include OO purchases. I know if this was done on my San Diego market, it would depict a far worse cash flow than the already bad cash flow that investors are obtaining. I find it unlikely that Austin investors are regularly purchasing investment properties that project negative $1,167/month cash flow (even though my last purchase my underwriting showed a little worse than this per unit (4 units), but it had value add and positive cash flow was achieved in less than 3 years).
Do you believe Austin RE investors are buying at a projected negative $1,167/month? I think it is unlikely.
I will also point out that if I purchased in my market a property that was negative $1,167, my worse monthly appreciation property is $2700/month. $2700 - $1167 =$1,533.00 monthly return not including equity paydown and that is my worse monthly appreciating property. My best is up ~$1m in 3.5 years. $1m/40 is $25k/month (by the way it is the same property that had the horrendous cash flow at purchase that I mentioned earlier in this post). Tough to make $25k/month in cash flow with less than 5 units.
by the way my underwriting does not show those cheap markets to have cash flow anywhere near the projections of those investing there. In general the investors grossly under estimate maintenance/cap ex, do not depict anything for PM and sometimes grossly under represent vacancy/uncollected rent. I saw a post recently that showed $86/month maintenance/cap ex and a vacancy rate of one quarter the city’s vacancy rate. The $86 was 10% of rent and is at least a factor of 3 low for sustaining maintenance/cap ex on that unit. I asked where he got the number and got an initial reply that he had calculated it via cost and lifetime. It was clear he used 10%. I called him on it and did not get a response. I asked how he justified using vacancy of 25% of the city’s vacancy rate and got a reply that he was in the suburbs with lower vacancy. I believe he could have lower vacancy, but 75% lower seems unlikely. Certainly it seems to be very aggressive underwriting. I pointed out he had no entry for uncollected rent so his 5% vacancy was covering both. This is the quality of the underwriting I see regularly in low rent markets. This under writing is unlikely to be sustainable over any reasonable length hold.
There are challenges in RE everywhere and I believe those in low cost markets should start there (but in the upper half of the price range of that market). I do not believe these markets are likely to produce the returns that OOS investors seek.
Good luck
Post: 4 Star Review because our river was dirty!
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- Poway, CA
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Quote from @Collin Hays:
I've had low ratings because the fishing wasn't good, or there were too many flies.
Was the fishing not good or the fishermen not good? Fishing can be bad for example after storms or heat spells, but poor fishermen always blame the fishing. What they really mean is the fishing for them was not good.
Interpretation: I cannot catch any fish so it is the host’s fault.
Reality: I have no clue how to catch fish in this area and that is the host’s fault.
Post: What if “Distress” Isn’t the Opportunity—But the Signal?
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Quote from @Stasiu Geleszinski:
Parker—this is dead on.
That IRR split test is such a clean way to expose what's really driving the business plan. If 80%+ of the IRR is appreciation-driven, you're not buying a cash-flowing asset—you're buying a thesis. And if that thesis was priced in a 3% rate world, it's already broken.
We’ve been using that kind of logic to reverse-engineer who’s likely to sell next. If an operator relied on heavy refi upside or zero cash flow to stay alive, and now rent growth is stalling, that’s often where cracks show up first.
Not always a fire sale—but definitely a trigger for movement. Timing those shifts is where a lot of edge is hiding right now.
Curious what other early signs you’re seeing in San Diego?
—Stash
>Curious what other early signs you’re seeing in San Diego?
according to recently released data by the California rental Housing Association the rents in the city of San Diego rose 9.3% over the last year. According to rent cafe tha average apartment rent in San Diego is $2975. So near $300 increase in rent on average.
I suspect non commercial residential is doing fine even if they purchased with some negative cash flow. The rents continue to increase and most owners have long term fixed financing.
The commercial residential with their shorter term loans may be having issues (everywhere, not primarily San Diego). I am an LP on a syndication offering of a local value add commercial apartment building. It is drastically under performing the underwriting; bad enough that I suspect to suffer a loss (it will be my 1st RE related loss). One of the two primary operators got a divorce and exited as a primary. I suspect that also may be impacting the performance.
Last week we placed an offer on a down to studs rehab. We offered $92.5k over the initial asking price with virtually no contingencies (we had HOA contingencies only). I was told at least 4 offers beat our price. I realize there are operators who are content with returns far less than we expect, but our projected return was only $20k to $30k with a reduced cost of money (-50% of what most would be paying). San Diego is definitely a healthy (over heated) market for smaller flips/rehabs.
Good luck
Post: Why markets with low appreciation grow your net worth twice as fast
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Quote from @Mike D.:
Quote from @Dan H.:
Case Shiller used to publish a list with total residential return for this century. The top of the list was all high appreciation markets. The bottom of the list was comprised of high initial cash flow properties. What the list showed was a strong correlation between appreciation and cash flow over a long hold. The list showed a poor correlation between long term cash flow and initial cash flow.
I invite you to run your numbers at 80% LTV using that extra down payment to deal with any initial negative cash flow. Use the appreciation and rent growth for this century on each city. Basically the case shiller data without the effort of determining local property tax, maintenance, PM rates, etc..
In have been investing in my San Diego market for many years. I have purchased with poor timing and great timing. My worse appreciating property has appreciated $2700/month over its hold ($47k down and closing). My best appreciating properties have appreciated over $10k/month over their hold. I suspect that virtually all residential RE in my market will have numbers between my best and worse case.
Knowing the San Diego appreciation rate (almost 6%/year for this century per neighborhoodscout) how do you think the rent growth has been?
With time the market with the higher rent growth will always have higher cash flow than the higher initial cash flow market that has lower rent growth. It is basic math,
So the high appreciation market has historically produced both better appreciation numbers and better long term cash flow than the low value markets. This is easy to verify and I believe most experienced investors ecognize this. I recognize past history is not necessarily an indicator of future performance but the metrics on my San Diego market still look promising.
My view is the low cost markets are best served by local RE investors who know the nuances of the area.
Best wishes
Okay, running the numbers at 80% LTV sounds interesting. If you do it for Austin, leaving all the other numbers from the initial example the same, you'd have a $2129 monthly payment on a 30 year loan with 7% interest, so -$14,296 negative cashflow. Since you are capturing the full appreciation on the property with a lower down payment, $80k, and since you now have larger principal paydown ($3251 in the first year), your return is now: cashflow -$14,296, principal paydown $3251, appreciation $28,000 = $16,955/$80,000 = 21.2% return. So far it looks good. So far.
And yes, you could now stick a very large amount of money in reserves to deal with the negative cashflow. Not sure what kind of rent growth you're proposing but let's say 5%. I used a spreadsheet that I had whipped up previously to figure out how much total you're going to need in reserves before the property starts cashflowing and was surprised to find that it still wouldn't be cashflowing after 20 years (!) and over those 20 years it would incur negative cashflow of more than $217k. The rest of the down payment you were going to put away in my example is only $145k, but that money grows at some kind of rate over the years so I suppose it would end up being enough to make up for all the negative cashflow this property would ever incur.
Even so, several large issues:
- The opportunity cost on the $145k is major. Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
- By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
- You are burdening yourself with negative cashflow for years when you could be in a different market with a higher return making cashflow which you can actually use to go to the grocery store and eat.
- Returns from appreciation are more volatile than cashflow in general and after going through this torture for years it is possible you could see very little payoff.
So, I don't see why someone would do this. I don't have access to the Case Shiller data you mentioned so I made some other assumptions that might be different. I'd also be interested in hearing if I misinterpreted something about what your idea was.
I agree with the thesis that high appreciation markets will eventually produce "better" (at least higher) long term cashflow because rent grows faster as well, but it takes a very long time and comes at the cost of low return on equity, to the point that you'd be better off selling out and going into other investments such as a stock/bond portfolio. You also have to consider the opportunity cost in the years when you're waiting for the cashflow to materialize.
I do not know if you switched numbers from your OP or if your calculation on time span to positive cash flow is off.
You show a negative $328/month on $2200 rent.
Without compounding (with compounding it would be better and take less time to achieve positive cash flow) using your rent growth percentage
1.05 ** years * $2200 - $2200 is the rent
at 5 years
1.05 ** 5 * $2200 - $2200 = $607.82 which is likely enough greater $328 to compensate for expenses other than P&i having risen (basically inflation on the non fixed costs).
>Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.
There are many ways to manage risk. I believe high diversification reduces risk. I think only a very conservative investor would have more than a year of safe, liquid reserves (money market, etc). So your reserve scenario does not match most investor’s approach. I do agree that the reserves should not all be in one asset class; that is too risky. But an investor has a year or so liquid and substantial other investment in other classes besides RE, they have a more robust plan than someone relying solely on cash flow.
>By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.
what ends up typically occurring is money is extracted before is gets to a 50% LTV to leverage the capital elsewhere reverting the cash flow. I virtually always have used 30 year fixed loans once stabilized for their safety but I have yet to hold a loan 10 years. With the rate increases that started q2 2022, there is a chance that I will finally hold one of these loans over 10 years.
My worse appreciating property has appreciated $2700/month over its hold. It never had negative cash flow but even if it did, it could not impact the return significantly. I purchased for $47k out of pocket including closing costs. My best appreciating properties have appreciated over $10k/month over their hold. One of these did have initial negative cash flow at purchase (quite large negative cash flow), but in less than 3 years it had positive cash flow. The negative cash flow was always inconsequential compared to the value increase.
I do believe the low cost markets are appropriate for local investors. Long distance investors should seek higher quality assets.
Good luck