Here's an idea. Go out home shopping and find a place that'll earn a typical $1000 a month in rent and offer the price on the home that will guarantee you positive cash flow if you buy it.
Let's say you can get a 30 year fixed with no down at 6.5% on a $135,000 home. Your payment would be $850 per month. Factor in taxes, homeowners association, tax credits, etc, for an extra $150 per month and there's the $1000.
So now that you found that place that'll rent for $1,000 a month, offer $135,000. Show the the calculations. Explain to the real estate clerk how homes have an inherent P/E ratio.
Oh, the shock value. Oh, the horror.
Why? Because now-a-days it's homes that list for $300,000 - $400,000 that'll rent for $1000 a month.
Now see the problem? We're not even close. The fundamentals are out of whack. People bought homes for crazy prices for the prospect or promise of future price appreciation, and not rental income potential.
Now that prices are falling, it's the P/E and only the P/E that'll matter. Just ask any flipper trying to rent out his dead inventory. Ask him how much a month in cash flow he's losing.
If I was back in Arizona, I'd go to home open houses with a mortgage calculator, and the first thing I'd ask the selling real estate clerk is what the place would rent for. Then I'd plug the numbers in and offer the price that would guarantee the property would be cash flow positive when rented.
Which, in Arizona, would probably be a massive discount vs. asking price.
Oh, man, would that be fun! And dangerous...
25 comments:
And that just about sums it up really. ROI (return on investment) had become a thing of the past.
My accountant told me to forget about return on investment last time I talked to him...........time to get a new accountant.
Once you start seeing 8% rental return, then it will be time to buy.....otherwise just keep the money in the bank......you are better off.
I concur, but is it feasible to think prices will fall back to a point in the near future to make it viable to buy? The amount of the drop would be huge and just cannot happen in one fell swoop? So if it occurs over time it could take a decade.
e.g. 20 year old Condos in my area that sold for 100-110k in 98-99 now go for 300k (350k at their spring/summer 05 peak). They rent for about the same, 1300-1400. W/ Keith's #'s that would mean a price of ~200k at 6% and thats cutting it close depending upon ever rising taxes, condo fees, insurance & as they age maintanence.
Most owners are new bubblicous owners can would take a 100k+ bath if P/E drove any offers right now. What will have to happen to bring sellers around to P/E driven prices?
General rule of thumb, take the rental amount and multiply by 80 to 100 and that's the most you want to pay for the home to guarantee cash flow positive.
Rent $1000, buy for $100,000....kinda hard to get those numbers to line up these days.
You forgot to add in the cost of upkeep into your 'Rent' number. Things like A/C, refrig., plumbing,paint etc. So now that 'rent' number must be upped to $1,100 at least,to break even, which will bring in less renters.
You poor bitter renters.
Fundementals don't matter.
It's different this time.
If you don't buy now you'll be priced out of the market FOREVER.
I fully agree with you Keith, but why aren't there more houses in this price range?
Who is making the big profits here?
The home builders? (questionable looking at their financials)
Or are the companies that rent apartments not profitable? (also questionable)
Is it really worth the headache of being a landlord for a lousy 8% return?
But here's the unfortunate thing: ROI doesn't matter if people are willing to keep overpaying. Sure, that property may only be worth $135K, but if someone's willing to pay $300K or $200K, then that's what it's worth.
So, how do we convince the entire country to refuse to pay more than a property could rent for?
not quite true. Factor in what you saving in rent (i.e. the principle you will pay off over 30 years minus the annual rent) + tax savings of perhaps $2,000 per year. Calculate that all over 30 years and you save some big money by buying over renting ($300,000 or so).
Of course, this assumes that housing prices are static and rents are static.
I moved out of AZ after Thanksgiving in disgust.
I'm following in the footprints of other young first time home buyers ( priced out by hordes of Clownifornians equity locusts) that have left the place never to come back.
AZ is de facto Kalifonia's slut. Clownifornians run the place like their own outhouse.
What a great idea! I wonder if we could start a bit of a buyer backlash. After all, the crazy prices can't continue if we are smart enough not to pay them!
keith,
i think most people who call themselves investors don't have a clue. i think they're buying these houses, not so much as an investment but as a prestige, where they can go to parties and brag about owning 3 homes etc. these are the people who lacks self-esteem and recognition. these are the people who wants to be accepted by society and this is the only way they know to be accepted. these are not investors and pretty soon, it'll catch up on them.
in coastal california, houses haven't been anything close to offering cash flow on anything less than 70% down payment for many many years...10-15 years
How long until would be realestate tycoons tire of using negative cash flow to capture negative equity. The fundamentals are the same, it's just that they're all negative numbers.
Hell, even Robert Kiyosaki told people to buy for income, not appreciation.
Yea the fundementals are way out of wack. Years ago when I bought condos and rented them, the rule of Thumb was to charge rent equal to one % per month of the purchase price. This would ensure positive cash flow even if the price did not appreciate. And that is what most rents were priced at until now.
Play with this tool:
http://realestate.yahoo.com/calculators/afford.html;_ylt=AgctYqrN3wDaBkhTxSUhJeykF7kF
I find it very frustrating here in San Diego, because price reductions are like Chinese Water Torture . . .people lower about 10K on a 600K property, and think they are doing buyers a BIG favor. I really do want to buy again some day, and I have done low-ball offers. Places that I lowballed 6 months ago are still on the market, but at only 1% lower prices. . .I guess people don't mind being bled to death a little at a time. It is like those people who bought Cisco at 85 and held it till $10. . .it still has gone no where near that price again, but people live in hope and denial. . .Keith - I am beginning to think this whole process will take 10 years. . .thoughts anyone??
This is exactly what we are doing in Arizona right now. We pay $1300 a month for a brand new 2100 sq ft house, we are the first to live in it. The flipper owner bought it at the worst possible time and is now renting to us for probably 60-70% of what his monthly mortgage payments are! We are quite comfortable renting right now, and with the money we are saving every month maybe we will buy it from him when the lease is up...If he is desperate enough to sell it at a reasonable price that is! If not, there are over a dozen more homes for rent just like it in our subdivision....We will just move on to the next one!
A while back I posted this on a forum about some $750K condos in Silverlake...in response to some idiots spouting that old, "if you're buying to own and not for investment, the ROI doesn't matter". It's long, but I think it makes your point nicely:
Equivalent rents in that area, for a nice two bedroom, would be about $2K a month, right? And let's see...the mortgage on $750K at 6% after factoring in a $150K downpayment (20%) -- money which would otherwise have gone to your retirement, or your emergency fund (the one that's supposed to contain a couple of months' salary in case you lose your job or get sick) -- would be about $3600 per month. Now factor in $250 a month in hoa dues, another $200 a month in property taxes...hmmm...We're talking at least $4000 per month.
NOW add to this the fact that liquidity -- the ability to sell your place quickly, if at all, for anything close to what you paid for it -- is drying up much faster than prices. Sales have been going down for about a year now -- last month they were down over 20% in LA County. Which means that, if you have to sell in the next couple of years (when even the NAR says prices will be flat to negative) it'll take you at least six months. If you're lucky.
Okay, so now you've got a $4000 nut to crack on a place you can no longer live in -- you got a divorce, or changed jobs, or just had to move someplace else...and you can only rent it for (at most) $2500 to $3000 per month. Worse still, that emergency fund you were supposed to have for just such occasions went into your downpayment. And that HELOC that might bail you out? Don't count on it -- not only has your property just appraised for $100K less than you bought it for, but interest rates are now through the roof as lenders make up for the loose-credit sins of the past by tightening credit standards.
You're screwed. Big time. That "equivalent rent" that everybody poo-pooed as not taking into account the "special magic happy premium" attached to the warm, cozy feeling of ownership actually serves a practical purpose -- as a hedge against the possibility of needing to unload the place in a down market.
Oh, but you say you'll NEVER have to move in less than five years or so, right? I mean, hip, young, rich people like you guys NEVER change jobs, or get divorces, or have to move for any reason at all...right?
The ultimate point being, of course, that having some semblance of sane relationship between the cost of renting and ownership is an absolutely essential hedge against unforeseen circumstances. Buying without considering this is just stupid and irresponsible. Period.
I just read a book by Gary Keller called The Millionaire RE Investor. Great book, with good fundamentals and past bubbles (tulips, etc) exposed.
I'm used to thinking in terms of speculators (gamblers in higher prices later on) or investors (for cash flow and all the old buy & hold fundamentals) but this book added another category:
Collectors.
People who buy stuff (like RE) regardless of it's income / loss and not necessarily because they think it will go up.
They buy on emotion (think Beanie Babies and Tickle Me Elmo) and although with RE they probably think / hope the price will go up, that is NOT the primary motive for the purchase.
As Anon 4:41:09 referred to...
people buying RE just for the sake of saying they "own" property.
For the "collectors," hopefully soon another fad of possession will come along, and they'll leave the Phx market along with the speculators.
Then maybe the investors (myself included) can get back to work buying property that cash flows.
And who knows... maybe it will even increase in value over time at inflation + X%... but we don't really care either way :-)
Asset Hunter
By the way... we moved to AZ in July '06, and we rent a lovely house from a gent who bought it in July '05 and then moved into a brand new house in July '06.
We figure he's making about 4% ROI... minus prop. taxes, maintenance, HOA, etc... but only IF he paid cash for this place.
Asset Hunter
Two things:
Despite what anonymous said at 2:55 -- there is no tax deduction on rental property like an owner occupied property
and second..
I live in a nice area and pay $1050 in rent. My place sells for about $190k right now. Although the fundamentals still don't make sense, it is not as out-of-whack as Keith states
Doug in Phoenix I agree with you and also know that a lot of landlords rent homes they've owned for years, not bought in 2005. There are plenty of 2005 investors but as a percentage of the total market? Most of my friends (we lived in Phx for 20 years) have rentals and all have positive cash flows. One friend kept his first house he bought in 1982 and it is almost paid for and he rents it cheap but still for 40% more than his PITI.
I think this is what keeps the medium rental price down, a lot of homes that are 10,15,20,40 years old, paid for or with small mortgages so they can rent for less. The newer places try to cover their expenses but have those older homes to compete with. Still, from my current search for a rental...to live in something nice will cost me $1300-1800 a month, not cheap in my opinion. At those rents I'd rather pay 30% more and be buying the place.
Since my wife is returning to her job after her former boss made her an offer she couldn't refuse, we return to Phoenix making more money but paying more to rent than had we just kept our house and turned it into a rental. When we sell here in Austin we'll make money but have already accepted the fact that if we want to buy we'll have to pay more for less.
I've been using this method to buy homes for years. Thats why I stopped buying in 2003. I sold all my rentals to stupid people that now have neg cash flow. I suspect I will be able to buy them back within 2 years and have positive cash flow again. In the meantime I buy silver and gold. I suggest you all do the same. When everyone is talking about gold I will sell it and buy real estate again. Never buy tops. I rent a nice 3/2 one block from the beach in central Fl for a fraction of the cost to own. Plus I have no headaches. Real estate will fall by 50% in the next few years. Toll brothers stock will sell for 2$ per share.
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