Betting on “the come” is a risky investment strategy.
Technically, that’s referred to as speculating. It’s when you have a hunch, or a gut feeling the price of something is going up. But there are no real estate fundamentals to support it.
That’s what’s happening in over-heated markets everywhere.
For example, I have over 20+ investor-customers who are waiting for a “fat pitch.” That’s when something is either mis-priced or the upside is so visible that an investment is a no-brainer (a no-brainer is a risky perception). So, we keep searching.
Why Real Estate Fundamentals Don’t Exist Today
You see, real estate fundamentals are hard to spot in today’s real estate market.
For example, look at this spreadsheet screenshot:
My ex-partner and I created this back in 1997 when we began acquiring apartment buildings in Southern California. I still use it today to see if a home or duplex or 20-plex passes the litmus test.
In this example, I found a $1.8 million tri-plex in Boca Raton and “ran some number” on it.
FAIL. Here’s why…
At the list price of $1.8 million, and 50% down payment, or $900k, and with current rents, you’d make 3.2% annualized rate of return (IRR). That’s a measly $2,500 monthly cashflow, or $30k per year.
Then if you juiced the rents to market rates, you could bump your IRR to 5% – about $4k monthly – or about $50k per year. Then you’re topped out.
These are Pro Forma numbers that don’t play out well. Why? Let’s look at some real estate fundamentals:
* Investors like leverage. 50% down payment is not leverage. Leverage would be a 75% loan-to-value
* In today’s market, rents are not going up, and more likely, easing – so forget the upside
* Homeowners insurance will come in around $15k per year, chipping away any cash flow
* The Pro Forma assumes 100% occupancy – one unit is now vacant
* An investor could put $900k into a dividend stock getting the same 3.2% IRR without management headaches of tenants and leaky faucets
For this purchase to just break even, an investor needs to put 29% down and get a 71% Loan-to-Value (LTV). At that point, you’d be speculating that things work out well. That rents would go up.
That’s not a sound investment strategy. It lacks real estate fundamentals an investor needs in order for the property to generate meaningful cash flow.. You might as well go to Vegas and take a chance having fun on black jack, gulping down a few free drinks and maybe getting lucky.
However, IF you paid cash for this tri-plex, you’d get a 5.6% IRR, or $102k annual cash flow, at current rents and 6.5% IRR at upside, or about $120k in cash.
Investors still have options. But traditional real estate fundamentals of using leverage when buying residential income property is almost non-existent today.
For investable real estate fundamentals to return to the market, prices and the costs to operate need to adjust down a lot. Or, there needs to be a return to rising rents.
Patience for now. Tread safely.
(Main Photo: Bankers Row – NE 2nd Ave – traditional Florida historic home)
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*** This downtown Delay condo may be what you’ve been searching for to enjoy warn winter months, or for year-round walkable fun
*** I published My November “How’s the Delray Beach RE Market” video yesterday where I dive deep into how long it’s taking to sell real estate
*** I’m NOT a fan of a 50-yr mortgage. Here’s the problem with a 50-year mortgage
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*** South Florida Real Estate Inventory is ABOVE 2019***
Last week’s supply was 57,714
Today’s supply is 58,187
*** Supply was Up last week ***
*** Supply is DOWN 19 of 27 weeks…***
