Breakeven opportunites are closer than you think

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Submitted by sdrealtor on August 22, 2006 - 12:10pm

A client of mine and I were looking at 2BR condos for her son and potentially as an investment. With 20% down and 30 year fixed financing, we found units that we believe could be purchased or will soon be able to (within 90 days) with carrying costs around $1500 to 1600/month in an area where rents begin around $1400/month. It's closer than you think and kind of shocked even me.

Submitted by an on August 22, 2006 - 12:12pm.

Please tell us where.

Submitted by sdrealtor on August 22, 2006 - 12:14pm.

Sorry but if it works, I will probably grab one and let a friend take one too.

Submitted by Daniel on August 22, 2006 - 12:43pm.

Sdrealtor,

I must say I'm not too surprised. The low end of the market (condos) is actually closer to turn cash-flow positive than the rest of the market. This is because condos are more volatile, get hit harder, and everyone nowadays hates them.

Also, rental demand is quite good at the low end, but not so much at the high end. Good luck turning cash-flow positive on a $800K property! The gross rental yield could be as high as 6% on a condo, but it is almost certainly below 4% on an expensive property.

Daniel

Submitted by Diego Mamani on August 22, 2006 - 12:51pm.

Are you factoring in the opportunity cost of the 20% down payment? Besides, your client should know that he won't be building much equity when buying at the peak of the cycle. When the son gets out of college in 4 or 5 years, he'll probably sell for less. And all those interest payments and lost earnings on the 20% down payment, will be money down the drain.

Back in the 80s I read in Jane Bryant Quinn's book that condos are the last to appreciate in boom periods, and the first to depreciate in busts. All the data I've observed since then verifies it.

Submitted by Daniel on August 22, 2006 - 12:55pm.

Diego asked...

"Are you factoring in the opportunity cost of the 20% down payment?"

I very much doubt it. Opportunity cost is something most people have trouble factoring in. I know people who bought their houses 10 years ago, have tiny mortgages, and point to their mortgage payments as proof that it is cheaper to buy than to rent.

Submitted by an on August 22, 2006 - 12:58pm.

Also, is this break even after the tax deduction or before?

Submitted by Diego Mamani on August 22, 2006 - 1:01pm.

Yes, the tax deduction helps. But against it you must consider HOA fees, property taxes, maintenance costs.

Submitted by Daniel on August 22, 2006 - 1:05pm.

After the deduction, I'm sure. Condo prices didn't already drop THAT much, did they? :-)

Submitted by lamoneyguy on August 22, 2006 - 1:07pm.

Yes, sdrealtor, we want to know the details. Not where the properties are, but the numbers. Purchase price, HOA, loan terms to get cash flow positive or close. Very interesting.

~lamoneyguy

Submitted by sdrealtor on August 22, 2006 - 1:15pm.

My client knows exactly what they are doing. Son is not in college, has a stable job/career he has had for over 6 years, needs a place to live and will get a roomate that will pay $600 to $700/month. It is within 2 miles of where he grew up, his job is and where we wants to live. If he needs to move in a few years, the place would still breakeven for the parents, will generate a tax loss and will be a good long term asset. As rents rise with inflation it should actually kick off some income in the not too distant future. We dont know what will happen and it works for them. The reason why it works is because condos have depreciated first. At the price we hope to get, it would be approx 25 to 30% off the peak.

Submitted by FormerSanDiegan on August 22, 2006 - 1:23pm.

Purchase price (or range) please.

This is a critical piece of info to evaluate GRM or rent-to-price multiples or cash-on-cash return from an investment property to determine the degree of the current sell-off.

Thanks.

Submitted by PerryChase on August 22, 2006 - 1:41pm.

sdrealtor, I'm also looking for one such property for my auntie/relatives to spend retirement times in San Diego. So far I've not seen anything close to fitting the bill.

The tax loss is a bunch of bull and I completely ignore it when assessing my options.  If I get a tax advantage, I consider it compensation for my troubles in owning/managing the property. In my mind, I think of tax benefits and maintenance and improvement costs as a wash.

If you clients rent out the place to their son, they have to deal with depreciation, recapture etc...  What a pain!

Oh, and in my mind, having the privacy of your own space is not the same as sharing it with roomates to help cover the mortgage.  It's a quality of life issue.    You only live once and, to me, physical comfort and enjoying quality food cannot be compromised. 

 

Submitted by FormerSanDiegan on August 22, 2006 - 1:56pm.

sdr -

I'd like to see the purchase price range to evaluate where we are in the cycle.

I own a rental property (SFR) that I purchased about 5 years ago that currently has positive cash flow. I like to run numbers every 6 months or so to gauge the market. I haven't been able to find anything (SFR) that cash-flowed since about 2001. During the run-up condos were even more difficult to cash-flow, but now you've piqued my curiosity.

I did a "guesstimate" on what I thought this property should go for, to produce monthly rent in the 1400 range and carrying coasts in the 1500-1600 range. Assuming 20% down, interest-only 30-year fixed, and a combined $300 for HOA and insurance, I come up with a purchase price of around 300,000-325,000. Mortgage ~ 1300/month I/O $300 per month HOA & Insurance.

Can you confirm or deny whether I am close ?

Submitted by anxvariety on August 22, 2006 - 2:03pm.

If you don't mind living in a shoebox conversion in Chula Vista!

If it's near breakeven, then it will probably be profitable if you wait until a real housing decline.

BTW, are you including property tax and HOA in the $1400 a month? I predict that you will present a gotcha!

Submitted by PerryChase on August 22, 2006 - 2:03pm.

FormerSanDiegan,  those are also the numbers that I'm looking at.  $300k is my price point for a good condo/townhouse.  

Submitted by no_such_reality on August 22, 2006 - 2:39pm.

And the big question:

With the condo glut, will you be able to sustain $1400/month in rent?

I don't see it, a $300K with 20% down and 6% loan rate has a probable carrying costs of $2050 a month. $2250 if you actually pay any principle on the loan.

Ah, I see, they're breaking even after taking the income loss and depreciation. At a combined 40% state & fed rate, 20% down and 6% loan, assuming 1% HOA, 1% maintenance, $300K purchase, it washes after taxes.

Submitted by sdrealtor on August 22, 2006 - 2:57pm.

All costs are before taxes not taking any tax benefits into consideratio, price is below $300K, location is in a relatively upscale area. That's all I have time for. Off to see the Red Hot Chili Peppers. I'll have more for you all 2morrow. Look for "Ode to Docteur" post coming soon.

Submitted by lamoneyguy on August 22, 2006 - 3:07pm.

I'll have more for you all 2morrow.

What a tease! C'mon, throw us a bone!

~lamoneyguy

Submitted by FormerSanDiegan on August 22, 2006 - 3:26pm.

n_s_r - Your math is off.

For a 6% loan, 20% down, you have 240K financed.
Ignoring principal payments, the monthly interest is $1200.
1% HOA = 3000 per year = $250 / month
1% maintenance = $250/month
Assume Insurance is ~ 100/month

I get 1800/month.

I think you included 300K as the loan amount (ignoring the 20% down).

Submitted by deadzone on August 22, 2006 - 3:27pm.

There is no way a condo right now is a good investment anywhere in San Diego. Throwing 20% down on a condo today is the same as throwing money down the toilet. It's likely to drop at least another 30-50% from today's prices, I don't care how much it is "supposedly" off its peak.

Example, condo for sale at 500K. 20% down is 100K. 5 years from now, condo may be worth 300K. In the meantime, buyer has accomplished the following:

1. Thrown 100K down the toilet
2. Thrown an additional, $100-200 per month down the toilet (when compared to the renting).
3. Is stuck with this place, cannot sell because they will be upside down for a long time.

Explain to me how this is "Break Even"?

Submitted by FormerSanDiegan on August 22, 2006 - 3:30pm.

I wouldn't buy it ...
but one might justify it for the son in the example.

From a landlord's perspective, this price is still about 25% too high to make it cash flow. Not good enough for me.

However, consider it from a renter's standpoint:
1. Pay 1400 / month rent
or
2. Put 60K down (gift from parents), pay 1550/month + 250 maintenance per month.

Assuming 30% combined state/federal bracket the renter, now buyer, comes out within $50 per month of break even. If you assume that they are also making principal payments of ~$250 per
month, that renter might consider buying the place with a fully amortized 30-year loan, rather than making upgrading their clunker for a late-model used car.

When SFRs get to this level, it'a time to buy.

Submitted by no_such_reality on August 22, 2006 - 3:50pm.

n_s_r - Your math is off.

For a 6% loan, 20% down, you have 240K financed.
Ignoring principal payments, the monthly interest is $1200.
1% HOA = 3000 per year = $250 / month
1% maintenance = $250/month
Assume Insurance is ~ 100/month

Property Tax = $300/month.

I figured Property Tax at 1.25% = $300/mnth. I included it but didn't list it. Monthly carrying costs before tax benefit is ~$2000 - $2100 give or take assuming interest only at 6%. Add $200 if doing a traditional 30yr loan.

So he's running short about $600 or $700 month. That's $7200-$8400/yr. depreciations is 1/27.5ths of the price or just short of $11,000 generating a tax loss of ~$19,000. At a 40% combined tax rate, you'd get a tax savings on your wage/1040-income of between $7200-$7800/yr. Thus doing an after tax breakeven.

If the condo is in the $250-$270K range with a lower HOA (say $200 or even $150), figure maintenance at $100 since HOA cover major external/common area things, you get closer to the $1500/$1600. There's a bit of funny money calculations with the HOA maintenance, insurance. HOA is set, but will it rapidly climb? Maintenance and insurance can be spun one way or another.

Submitted by no_such_reality on August 22, 2006 - 4:03pm.
Submitted by FormerSanDiegan on August 22, 2006 - 4:04pm.

OOPS My bad ! I should be harshly scolded for excluding property tax. Need to consult my spreadsheets rather than off-the-cuff.

So, the condo would have to be in the 250-270K to make sense for the renter to purchase IMO. Must be cheaper still for a landlord to consider wrt cash flow.

I've scoured ZipRealty in the areas that I know well (central and Central coastal SD), and found maybe a handful in the $325K range that are in areas that might rent out near $1200-1300. Most would rent for 1100-1200 at best. Must be somewhere else in SD.

Maybe it is adjoining rooms at that National City hotel conversion.

Submitted by FormerSanDiegan on August 22, 2006 - 4:06pm.

This thread should be re-titled:

"Beware ! Objects in the mirror are farther than they appear."

Submitted by sdsundevil on August 22, 2006 - 4:14pm.

First off, insurance will be less than $100/month. We play less than that on our house. I believe all you need to insure for a condo is the interior as you don't own the exterior. Probably depends on the condo layout, etc, but I would figure closer to $50/month and it may be even less than that. FYI, our insurance is through Farmers in case people want to see if they can do better.

Secondly, from what I know and truly believe, rents NEVER go down. I moved here is 1994 when the market was tanking and my rent went up every time I renewed my lease between 1995 and 1998. Eventually, it was just plain stupid to rent as I paid less each month to buy.

20% down tied up could be risky, but only in the short term. Meanwhile, positive cash flow seems to be within reach in the short-term. If the property is in a good location where it will have a high occupancy rate, there isn't too much risk. If the numbers work, they work.

I agree that now is not a great time to be buying condos as they will most likely decrease fairly significantly in short term, but it really isn't a bad deal if you are in for the long-term.

As for people predicting 40-50% depreciation in property values, I think you are crazy and have little justification besides correction to the mean. A correction to the mean doesn't have to happen instantaneously and likely won't. Probably spread out over the course of 5 years, which means maybe 20% or so is a reasonable amount to predict.

Submitted by no_such_reality on August 22, 2006 - 4:15pm.

FSD, will those rents go down? They're ~$1200 now, but will those prices go down as the condo glut starts to face losses and rents them to stem the bleeding of the cashflow?

Or will owners hold the line on the rent and face longer vacancies since downtown has so many empty condos?

Submitted by no_such_reality on August 22, 2006 - 4:19pm.

Secondly, from what I know and truly believe, rents NEVER go down.

In 1996, I moved from a 2br 2ba apartment at $1250 to a 3bd 2ba house at $1050. The house was in a better neighborhood.

Apartment complexes were really uniform on rents. Renting private residences and prices were all over the map.

Submitted by SD Realtor on August 22, 2006 - 4:28pm.

I guess I look at it like this...

If I could buy a rental right now that almost breaks even... and by most all accounts rents dont go down...then why not park my cash (that 20% down) in a CD for a year or two, and then buy that same condo, that in all likelihood will depreciate, and I will do much better then breaking even?

Also sdsundevil I have already seen depreciation in many zip codes that exceeds 10% of thier highs just 2 years ago. In other zip codes for attached housing I have seen even more substantial numbers. If you want check out 1 or 2 bedroom condos in Mission Valley, UTC or San Carlos. So I think that your correction of 20% over 5 years does not correlate with the data I have seen. The simple statement by sdrealtor that he is seeing reasonable pricing now that is approaching the break even point in and of itself supports a substantial depreciation that has ALREADY occurred in the attached housing market for certain zip codes.

Submitted by FormerSanDiegan on August 22, 2006 - 4:57pm.

n_s_r -

Rental rates will depend on the economy, namely jobs, weage inflation and interest rates. Average rents tend to track inflation.

I'd bet on 4% annual rental increases over 5 years.

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