October 20, 2007

It's the P/E stupid. It'll always be the P/E stupid.

Here's a typical real estate investment spreadsheet. Just doing the math. Feel free to play along at home.

Monthly Rental Amount $2,400.00
Percent of Year UnOccupied 5%
Take out for Vacancy for Annual Cash In of $27,360.00

Property Acquisition Cost $300,000.00
Less Down Payment - Cash In $60,000.00
Amount of the loan $240,000.00

Payment Monthly Pricipal/Interest $1,556.64
Annual Insurance Cost $1,200.00
Annual Taxes $1,400.00
Annual Repairs Budget $600.00
Percent of Rent Mgmt Fee of 6%
These expenses total to Annual Cash Out of $23,521.28

Income of $27,360 minus cost of $23,521 = $3839 cash return over cash out

$3839 divided by cash investment of $60,000 = Rental Yield of 6.4%


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Now here's the example for a typical overpriced Phoenix condo (real numbers based on personal experience. And I'm actually being kind as rent would have been around $900):

Monthly Rental Amount $1,100.00
Percent of Year UnOccupied 10%
Take out for Vacancy for Annual Cash In of $11,880

Property Acquisition Cost $300,000.00
Less Down Payment - Cash In $60,000.00
Amount of the loan $240,000.00

Payment Monthly Pricipal/Interest $1,556.64
Annual Insurance Cost $1,200.00
Annual Taxes $1,400.00
Annual Repairs Budget $600.00
Percent of Rent Mgmt Fee of 6%
These expenses total to Annual Cash Out of $23,521.28

Income of $11,880 minus cost of $23,521 = NEGATIVE $11,641 cash return over cash out

-$11,641 divided by cash investment of $60,000 = Rental Yield of NEGATIVE 19% PER YEAR

PLUS: Unit is now depreciating at least 20% in 2007, 10% in 2008 and 10% in 2009, total value decline of $105,600 over three years.

Add in the three years of $34,923 in negative income and you've lost $139,923 on your $60,000 investment in 36 months. Add in inflation every year, or what you could have made investing in gold, oil or even CD's and your real loss is even greater.

Bottom line - if you listened (or listen) to a realtor on commission and buy a place with negative cash flow today that is also dropping in price, you're a fool, and you'll likely go bankrupt.

And that's the math. Housing crash style.

16 comments:

GreedKills said...

Keith...if you're gonna be posting the Phoenix P/E's to show that it's out of whack then you need to start looking at Craigslist in Seattle and comparing the condo P/E's in Downtown! It's gonna be ugly here.

We have you Phoenix condos beat by a mile! and TONS more currently under construction where the people with deposits are probably starting to consider whether or not they want to walk. The deposits here were pretty low to reserve places so people will walk in droves.

Oh...and Countrywide was heavily involved in condo loans up here and still are the "preferred" lender for some places.

Anonymous said...

Your going easy on the RE taxes. The Phoenix condo; 3K a year at least. :)

stuckinthecity said...

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I have a guy here in Chicago that bought a second home a small 2 br 1 bth to flip it. The flip flopped and his rent is -$500 a month from his total expense. More soon when they raise property taxes like they want to.

stocksystm said...

Thanks for putting it in black and white. This illustrates why we have so much further to go on the downside.

Kent said...

Yeah, but Keith, that financing is no good. I got a 1.5% toxic ARM - that changes everything! Price $300,000; down payment $0. Loan $312,000 (why not toss in closing costs?). Rent $1100. First year payment: $550. See it all works beautifully! And just think of what the property will be worth later because it's ALWAYS a good time to buy!!! Now if I only had actual income & good credit.....

Anonymous said...

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This sounds like the math of an INVESTOR.

Ain't been many of them "old school types" around lately, with the hyper & unwarranted appreciation.

You don't need a calculator to be a speculator... only someone to do the thinking and cheerleading for you.

It's going to be fun to get back to discussing investments some day in the future.

For right now, it's the backwash of market value depreciation in most people's minds as the bottle empties.

Good example!

Asset Hunter

6% Realtor said...

Bottom Line is positive cash flow. Never go in on an investment with negative cash flow, planning of reaping the upside of "assumed appreciation" - that's basic investing 101. Anyone who gives or follows that advice is an idiot.

Any real estate agent giving that advice should have their license pulled asap - the average real estate agent has no education, experience, or training to be giving investment advice.

Not familiar with the Phoenix market, but her in Sac (Forbes ranks as #5 worst in the US)your depreciation forecast is too aggresive. You also only look at the worst years for appreciation - this year and the next two. You should look at a 5 - 10 year forecast for appreciation rates - the blended rate will lessen the impact of the next three years. Here in Sac the average depreciation will probably be about 12% in 2007, and I'm thinking 8-10% in 2008, 4-6% in 2009. Where i'm invested the depreciation should be about half that. You also didn't account for a growth in rental rates over the next three years (unless your forecast is 0).

I've got some rental property in the area - all positive cashflow, vacancy about 4% per year on average. Long term appreciation is positive - on leveraged dollars. I've got strong equity positions in all the properties. Manage them myself, so I save the 6% management fee. That said I stopped buying investment property in early 2003, and will not buy more until the fundamentals improve (probably late 2008 to 2009). For me, real estate investment works very well, but again the bottom line is POSITIVE CASH FLOW and location, location, location.

Anonymous said...

What are some of the "other" Golden Rules of Real Estate?

Some guesses??? (set me straight):

A house should be 3-4 times gross earnings.

A house monthly payment should be no more than 33% of take home pay.

The cost of a house was historically about 100 times the monthly rent.

Others?

Thanks,

Marky Mark

Frank@Scottsdale-Sucks.com said...

LOL. During my last year in Scottsdale I paid $1,500/month for a condo at Kierland that sold for $600,000.

We lived in the luxury condo for pennies on the dollar while our landlords lived like paupers in a white-trash ghetto shack in the dumpy crime-ridden part of northeast Phoenix off Bell Road.

I guess they listened to realtors on commission.

Here in Newport Beach I pay $3,500/month rent for a house that sold for $1.2M at the peak and is now selling for around $800k. I figure it will drop to around $400k at the bottom. A friend of mine who is a very successful real estate investor agrees that it will no doubt drop to $400k in 12-18 months.

That's 1/3 what it sold for at the peak for you realtors who cannot do simple math.

Anonymous said...

debt = wealth

when you're maxed out, cry to congress for a bailout

Anonymous said...

"You don't need a calculator to be a speculator... only someone to do the thinking and cheerleading for you."

Speculators come pre-programmed with all that software and if not there is the tv and friends to indoctrinate you.

Anonymous said...

Kieth:

In the first calculation, you cannot take the 60K down payment out- it is a cost and should be included.

Anonymous said...

'debt = wealth

when you're maxed out, cry to congress for a bailout'

and that's just the bankers and hedge funders.

keith said...

The 60k is in there as this is the example a real estate investor would use.

Usually an investor wants to invest capital and see a return on that investment at least greater than what he could achieve in other asset classes like stocks or bonds

Today I think a 7% or 8% ROI would be expected.

What's NOT expected (or tolerable) to a serious investor is a significant negative cash flow return.

Only an idiot would buy a house with a 20% negative return on capital employed.

Better at that point to just go to Vegas and play craps

Anonymous said...

Keith,

Your math is good but you discount the fact that there are great deals around. I bought a 2 bedroom condo in Bangkok for $180,000 in 2005 (paid cash in full so I'm a real owner, liquidating my savings at the time).

I live there with my wife and get $3500 a month reimbursement for housing expense by my employer in addition to my salary. There is no property tax while I own, it is paid as a fee when selling (about $10K USD). My condo fees are $150 a month, figure another $250 a month in utilities.

So... let me do the math. $180,000 down and $42,000 in rent per year minus $4800 in expenses... so that's $37,200 in profit or a 20.6% ROI for a full purchase with no interest paid. And I don't have to pay rent, what a deal!

Wait it gets better because when I bought it was 41 baht to the dollar and now it's 33 baht to the dollar, thanks Ben for that. So now my place is worth about $280,000.

If I rented the place out it would go for about $1500 a month so that is still a 7.3% ROI. Your math is good as I said and there are still good deals out there. Just keep your eyes open!

My only regret is I have been keeping my cash in USD and that's getting devalued by the day. However I believe this will cause a global problem and the dollar will swing back relative to other currencies. Maybe I take a big risk here but I'm not keen to buy gold at $760 an Oz. I did have a hunch to buy oil at $59 a barrel but didn't act on it. Stupid me. Oh well, I'll be patient and see what happens.

It helps when you make $250 K per year in addition to housing.

-Big Cheeso

bottom feeder in philly said...

It's time to buy when you can cash flow fully leveraged. My 80 unit portfolio was bought with no cash of my own, and the cash flow is strong enough to live on when needed. That is true Real Estate investing when you can create something with nothing. I'll be a buyer again when there is seller financing, subject too's, good short sales, cheap REO's, and lease options at the bottom of the curve. I can't wait to be a buyer again.
Bottom Feeder in Philly