Investing in real estate

Now may be an excellent time to make a real estate investment, particularly in Texas. We have seen strong rental value appreciation over the last three years in all five major Texas metros, but particularly in Austin and Houston, where over the last ten years we have seen a 60+% increase in rental rates. This is much stronger than value appreciation and wages over the same time period. Maybe the bigger question from investors, is “Will values hold?” Based on current demand and inventory in all metros, I say yes.

We buy property in hopes that our investment will generate some kind of return down the road. The chance of that occurring is very low if one does not hold the investment for at least five or more years. The reason is that transaction costs, repairs, monthly ownership costs higher than comparable rent, and ownership hassles dictate that it is better to invest your money elsewhere and stay as a renter if you are not sure you will own long term. Therefore, since you are going to be a long-term holder (the longer the better) you really should not be that concerned with short-term market price fluctuations. Even during the recession this was true, if you looked at real estate investment from a longer hold period, such as ten years plus.

Nationally we have seen a slowdown of the large investor funds, known to many as vultures because they swoop in and buy “distressed properties” — foreclosures and short sales – cheap. Other parts of the country experienced this, places like Las Vegas, Chicago, Phoenix, Atlanta, and Miami were popular because home prices there dropped as much as 70% at the bottom of the market.

We aren’t seeing this kind of investment strategy in Texas. We never saw the run up of values like those other markets did. Therefore its difficult to profit on flipping/speculating on the housing market in Austin. Are we seeing the vulture groups? Again, not really. What we are seeing is true real estate investors who are looking long term. Once they analyzed their decisions based on home-price appreciation, which is very speculative. Now they consider potential rental profits, which are far more stable.

When planning a residential real estate investment, do not even factor in price appreciation for at least a year. After that, calculate only a 3% annual increase or less — a return that won’t turn heads of investors who only want to buy low and sell high. Look for cash flow. Know that you will have to put 20% to 30% down on the investor loans. At today’s low interest rates, they’ll get a near 5% loan, 20% down. Figure another 10% of the price for property management (unless you like getting calls in the middle of the night to unstop toilets, etc.), 10% for maintenance, an 8% vacancy rate, plus taxes, insurance and other home ownership expenses.

Cash flow vs. appreciation

• Properties that appreciate quickly are generally in higher income areas (desirable) and generally don’t cash flow immediately. But, you should look to increase rents to cover your mortgage payments within a minimum of 12 to 24 months.
• How do you rate good opportunities? I start with costs (rates, values, rents) that are low, with some upside. Historical trends and history as well as potential conservative appreciation.
• Raw land is not going to have cash flow. As we have stated before, there is a limited number of developable lots. There has been limited funding (bank loans, etc.) for development. If more product is not coming on the market to compete, rents will increase – less supply, therefore values increase.

Although conditions are very favorable, investors have to be adaptable because the market is evolving rapidly. It’s the income from rentals that’s paramount right now. The beauty of cash flow, of course, is that even if prices declined 10% or 20%, the investors should be able to live with that. Investing in rental properties is a long term investment strategy. You need to look at a minimum of five years to hold. As always, you need to visit with your CPA, financial consultant, mortgage professional, and real estate professional before you dive in.

What do I look for in real estate? I look for an investment almost like dating or getting married. You should be concerned about finding an investment that you “love”— one that fits all the right reasons. Once you invest, that investment will be part of your family and financial planning for a long time! If you are looking for a ‘quick fling’ in real estate, I would look at other investments. Real estate investment typically is a long term play.

What things should you look for?

• Location, location, location. First rule of real estate.
• School district and schools are paramount after that in all price points. The higher the demand for the schools in the area, the higher the rent and value.
• Jobs! Long-term strong employment is what you want in your metro. Without jobs, demand is less, and your rental property may go vacant.
• What type of investment are you comfortable with? Do you need cash flow immediately? Is leverage important? The answer is typically yes, but be careful, should the market shift negatively, you do not want to be overleveraged or ‘underwater’ on amount borrowed vs. value.
• For experienced investors, most expect less than 5% appreciation and look for positive cash flow from day one. With today’s current values in Texas, most residential rentals are able to achieve positive cash flow.
• It is fairly priced relative to the recent comparable sales in the immediate area for similar properties? Look at values over the last 5 to 10 years in the area.
• Vacancy isn’t too high in the area. This is very important whether an owner occupant or investor. Empty unstable neighborhoods or communities have a higher risk of vandalism and risk downward price spirals. A lot of times this is a byproduct of neighborhood schools.
• It is in decent shape and doesn’t need much fixing-up. Skip the massive fixer uppers, the ones with foundation issues, or anything labeled as “needs a little TLC” in the listing, as that means it is a wreck. Leave the fixers for the contractors, they know what they are doing….. doing it yourself doesn’t usually save you much money.
• If there are big vacant parcels question the use. A non-residential zoned parcel, empty or retail/industrial/etc. site where you are not 100 percent sure what is going to be built there could affect your values later on. Confirmation of use is the best insurance of protecting your investment. A new use of that land could impact your “quiet enjoyment” of your residential rental unit.
• You complete the proper due diligence steps to reduce your risk as much as possible. Mind your contract terms and contingencies, pencil out your deal, get a couple of bids on financing and dissect your GFE, review the HOA condition, review the property condition, make sure you have the right type and amount of property insurance in place, make sure you adequately review the title abstract and title policy and everything else you need to do to lower your risk.
• Affordability! Record low rates and stable values in most Texas metros compared to the rest of the nation makes this one of the best buying opportunities consumers have seen in years.

History is a great teacher, however the last seven years were an anomaly in real estate investment. If you bought at the bottom, good for you. Those type of discounted investments only come along once or twice in a lifetime. If you are going to buy, look to the above suggestions. Get with the professionals and listen. Find a mentor that has done this before. Find a house you love or rental property that makes sense, that you will own for a long time, is in decent shape, lock in long term financing, and sleep well.