The California property Roller Coaster
The California Real Estate Market is quite the roller coaster. In the
70's it was flat, in the 80's it spiked, in the 90's it fell, in the
earlier half of this decade it shot through the roof, and now it appears
flat again. This up and down performance has many analysts, investors
and economists scratching their head, and postulating about what the
upcoming year will do for California real estate. All the advice of
which is for not, because no one truly knows. However California isn't
as hard to read as all of that.
First understand the history.
In the 70's real estate was flat because interest rates were extremely high.
In the 80's huge investment in technology and aerospace brought lots of jobs to California
In the 80's the interest rates came way down as well.
In the 90's aerospace jobs and tech jobs hit a wall, and left California
In the late 90's tech investment again surged
In early 2000 the interest rates came further down
In mid 2000 the internet bubble burst, with many people looking for new investments
Property values rose tremendously through this period
Investors started using the 1031 exchange programs to "buy up"
Interest rates continued to decline
Jobs were returning to the state in droves
Interest rates started to creep up
Affordability dissappeared
The average home was over $500,000
"Creative Financing" became popular
Interest only financing & longer term mortgages grew in popularity as well.
Now with that, let's look at the realities of California's market -
The average home is over $500,000.
In most urbanized areas that figure is closer to $800,000.
In order to afford that mortgage, household income needs to be roughly $172k.
The average household income in California is roughly $75k.
With that salary, the average household can afford roughly a $350k home.
In
order to command a rent of $2000 (what the average household could
afford), an investor would have to put roughly $150,000 down on the
average home, and $450,000 on the average home in an urbanized area.
So what has happened?
- With high prices and salaries not keeping pace, there has been a huge slow down in purchasing homes.
- Investors have moved further and further away from urban areas in order for their deals to pencil out.
- 1031 exchanges have driven up the prices of everything from homes to office complexes.
- People are holding off on buying homes.
- Sellers are either oblivious to the realities of the market, or panicing to get rid of their homes.
- Builders are half built on many projects that may not get the expected return when plans were submitted.
- Land values have shot through the roof, making new construction a difficult proposition.
Add
all of that to the fact that this is the traditionally slow time of the
year for real estate, and there is a lot of speculation that this
market is finished, and that investment is not a possibility. This
however couldn't be farther from the truth. You need to know where to
look for investment opportunities.
Flipping
Not
a highly likely prospect unless you can get the property well under
market & also down encounter tenancy deposit not protected situation. Depending on the situation of the seller, this may be
possible. Most sellers have a great deal of equity in their properties,
but haven't kept them up to date. They typically don't want to take
the time to upgrade the property, and an investor familiar with
conducting these projects could make a great deal of profit by
constructing the right deal. One word of caution, in California with
average prices being over $500,000, real estate commissions are likely
to start at around $25,000, so build that into your budget.
Foreclosures & Pre-Foreclosures
This
is a real opportunity for many investors. Look for the people who over
extended themselves through Adjustable Rate Mortgages, 100% +
financing, and the like who may have some equity in the property, but
are facing a baloon payment. They will need help, and there is room
there to move on the property.
Distressed Properties
This
is a real opportunity because now that buyers have the ability to be
choosy, properties that have equity but don't have modern amenities can
be bought up at a profit for the seller and a bigger profit for the
rehabber.
Condo Conversions
Make
sure that you have a good attorney to help with this, and make sure you
work well with the city on this issue, because plenty of people have
screwed these deals up. However if you can pick up an apartment
complex, and carve them into separate ownership units, you can see a
property you probably picked up for $150k a unit turn into $250k or more
a unit when resold. Again, get a good attorney on this, and even
better contractors.
Short Sales
Bone
up on these deals. This will likely be a good opportunity for
investment in California, many foreclosures will be settled before the
court date, and working with a bank is a great way to be involved in the
process. There are plenty of formulas and advice out there for how to
figure this process out. Learning this process will help the investor a
great deal.
Types of investments are also something to
consider. Here are some thoughts on the types of investments out there,
and how to engage them in an investment strategy for California.
Condos
These homes will be great investments for a couple of reasons -
1) They are still relatively affordable, and attainable to the young professionals starting out.
2) These units are still easy to rent as they are similar to apartment complexes, but typically with a little better tenant mix.
3)
Just as young professionals are trying to get into the market, baby
boomers will likely look to condos as an opportunity to downsize.
Condos
can be a good place to find potential growth to rental and property
values. The cautions an investor needs to address in these deals are -
-
The Association Fees. Some are low, some are insane. Since this is
not a tax-deductable expense, don't buy into a property with higher
fees.
- The roofs. Many condos were built in the 80's when shake
roofs were still legal. This is a huge potential expense that owners
need to be prepared to incur.
- The area. Make sure it is close to a city center for the most appeal to renters and buyers.
Single Family Homes (Resale)
Excellent
opportunities. Rents are likely to go up over the next few years due
to the high cost of ownership. Buyers are starting to panic because of
their carrying costs, and the appearance of the market. If you have
enough available cash to make these exchanges work out, you will do well
in these markets over time.
Single Family Homes (New Build)
The
publically traded builders will likely unload properties in the
upcoming month. We've seen it in other markets, builders trying to get
product off of their books for reporting, so they offer great discounts,
incentives and upgrades. Currently many are not offering them as they
are trying to squeeze out the last few investment dollars possible.
However they will need to start those offers this upcoming month. Keep
an eye open for those opportunities
Smaller Apartment Buildings (Less than 4 units)
This
depends on your risk tollerance, and how much you can invest.
Splitting a duplex into 2 for sale units can be very tricky with a lot
of legal attention, which will cut into your profits. So you have to
look for holding value and rent potential.
Holding value will be a
long term strategy here. Prices are relatively high compared to the
cap rates. However if you can get the right deal, that is commanding
low rents, could be cheaply rehabbed, and is in a good location. You
are looking at a potential gold mine. Here's an example -
4
unit complex of 3 2x2 units and an owner's 3x2 unit. Rents on the 2x2's
being approximately $1000, and the 3x2 getting $1250. This would be a
little under market in most areas. If you are in a good area, you could
probably get closer to $1250 on the 2x2s and almost $1700 on the 3x2.
Add on to that the estimates that rents will increase between 7 and 10%
each year for the next 3 to 5 years, and you could see some real upside
on those rents.
Your acquisition cost is probably around $200,000
a unit. So your 4 plex is going to run around $800,000 under these
conditions. With rent coming in at $4250, you are looking at a per
month loss of $750 - $1000. Once you raise the rents to market rates,
you are looking at a $1200 a month positive cash flow. A conservative
estimate would put your rental income in 5 years at roughly double the
current rates. Cash flowing more than $3,000 a month positive cash
flow. And this is assuming conventional financing, and conservative
rent growths of only 5%.
Medium Sized Apartment Buildings (5 to 15 units)
Make
sure you have a good property management company. However buildings of
these sizes have fewer vacancy rates to contend with, and as such may
be a more suitable investment. Rents tend to be closer to market on
these properties, so the upside potential isn't as great. Still the
estimated rent growth over the next few years makes these properties an
attractive investment.
These property estimates show what the
smaller investor should be looking at as potentials in California. Even
though our rollercoaster appears to be cresting, that crest is only in
property values, not potential rents, or rehab possibilities. The
California investor needs to shift from a focus on the growth of the
properties to a focus on the growth of the property's cash flow. And
that is where the opportunity is in California.
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