Investor exhaustion with investment properties hits: Blackstone’s acquisition pace has fallen by 70 percent from peak last year. Running the numbers on rentals in high priced markets.
Existing home sales had another weak month and the blame continues to be on the notorious polar vortex. On the other hand, California is in a record drought and we are in an endless summer yet sales have hit multi-year lows as well. Could it be that over paying for a pre-World War II house is not exactly fitting in the budget of the regular local buyer? It is one thing to speculate but another to see what is happening on the ground. The granddaddy of rental investors, Blackstone has tapered off its investment buying binge dropping in acquisition volume by 70 percent from their record highs from last year. These are folks that run the numbers in bulk. I speak to many local investors and many have not purchased properties in SoCal since early 2013 since the numbers simply did not make sense then and they certainly do not make sense now for cash flow opportunities. The rest of investors are the late comers and the speculators, otherwise known as flippers. It is interesting to see the mindset shift once again similar to 2006 when the volume was turned up so high that even uttering the words “correction” labeled one as a “doomer” or some other attack not based on numbers. Unless you see real estate going up forever, you are basically camping out in a nuclear war shelter counting your stockpile until the end of days. Yet numbers matter. In many states and in certain markets, prices do make sense and have room to grow. Not so much in California at least in the short-term. This is why as we mentioned a site dedicated to housing data Zillow has reached 70,000,000 unique readers a month. Apparently “setting it and forgetting it” does not apply to housing. Let us run the numbers assuming you were looking for cash flow properties in Arizona and California.
Looking at investment properties in Arizona and California
In SoCal $500,000 gets you very little especially in L.A. and Orange Counties. It might get you a nice condo in a sought after market. As an investor, you are looking at cash flow on a variety of fronts. Tax benefits are overplayed in many cases and most long-time investors understand this. In fact, most seasoned investors will tell you to allocate close to 50 percent of your gross rents to costs outside of the regular mortgage payment. Many investors that I know are not your Blackstone’s. They are folks that buy properties with at least 25 percent down and finance the rest through conventional banks or through other lenders. They do put a large amount of skin in the game so the numbers absolutely matter.
So let us take an example of two markets right now with Arizona and California. It is very doable to find a $150,000 property in Arizona that will rent for $1,500 and a $500,000 condo in California will get you close to $2,500. This is very common. For some $500,000 in SoCal seems like a great deal so we’ll run with that. I think people assume that this unlimited investor buying spree is going to continue deep into the future. We are already seeing near record low sales volume even though prices went crazy in 2013.
So let us put together some figures here:
Sure, some will tell you to close your eyes and simply pick a place and buy since real estate always goes up in certain markets. But for investors, numbers absolutely matter and if Blackstone was optimistic on the future they would be buying up these high priced properties but they are not. I think the above numbers highlight why investors are balking big time. Novice investors will throw out figures like “that $2,500 a month in rent on that $500,000 home is great!” $30,000 in gross rents seems great when you don’t crunch the numbers. They fail to mention that you will fork out $132,000 of cold hard cash and still have a $375,000 mortgage as well. I was very optimistic on the low HOAs above because in some areas in Orange County HOAs of $300 and higher per month are routinely common especially with condos.
You’ll notice that even in Arizona that $150,000 investment property with 25 percent down is going to bring in something like $445 per month assuming no vacancies, maintenance, or other unforeseen costs after your outlays are factored in. Your tax benefits will absolutely depend on your tax bracket but if you are shelling out this kind of money, you are probably already at a very high tax bracket so any rental income you get is going to get taxed nicely. Something tells me Blackstone is not a poor organization.
But look at the figures for California. You are running in the red with a 25 percent down payment here. This also assumes you are fully rented, no monthly expenses, and you don’t need to do any major repairs. People are waiving contingencies on these crap shacks and fail to realize that a roof or slab work will likely eat up a few years of profits. Plumbing work? Flooring? Labor is not cheap in SoCal.
What about appreciation? This is where speculation dives in and this is why a correction is very likely to occur. You pay rents from net monthly income! Investors are 30 percent of the market in SoCal. If they are seeing these crude numbers is it any shock that they are slowly pulling back? So when the year-over-year gains go stale and even negative (which is very likely) do you think they will ramp back up? The current pace makes no sense for investors already. The only reason to purchase would be to flip and this is practically the definition of a mania if we are not seeing underlying incomes increase. It is also why California is largely becoming a part of the new renter nation.
As an investor seeking out rental cash flow you can see why investing in California overall is a poor proposition. The momentum we see today comes from the 21 percent jump in the median home price in 2013:
It is interesting to hear those that talk about gains not actually putting their money where their mouth is. If you assume that prices will go up, go for it and buy that house in Culver City or Pasadena. Why not? This is a sure bet from their perspective. Make it a rental and reap those unlimited rewards. As I mentioned from talking with investors that are deploying their own hard cash, California is not even on their radar. The flippers on the other hand are still out there. Whether you rent or buy, you should understand the nature of running the numbers especially on the biggest purchase of your life. California for a generation has been nothing but boom and bust. So it is interesting to hear these same people talk about a permanent plateau as if this was the history of SoCal:
The facts show boom and bust. Just the reality of our market. I’m sure the 7,000,000 folks that lived through a foreclosure wished they ran the numbers.