Going "All In"

Renting rather than owning. Has the time come to be a landlord? An article in the Wall Street Journal on Saturday described a June 2009 survey by the National Foundation for Credit Counseling that discovered a deep pessimism about home ownership. 33% of all respondents do not believe they will ever own a home. 42% of those who once purchased a home, but don’t own one now, believe they will never own one again. While 66% of all families in the USA own their own home, that percentage is declining and is highly correlated with culture and race. Minority home ownership at the peak of the housing market in 2006 was less than 50% for blacks and Latinos and those percentages do not look to increase in the near future. Minority home buyers in 2006 assumed sub-prime mortgages at twice the rate of white buyers and similar statistics exist for foreclosure rates. So where are these families to live? Even if renting isn’t as fashionable as home ownership, it may be the only alternative for many. Also remember that a short sale impacts the sellers’ credit (and thus their ability to qualify for a loan to purchase a home) for a minimum of two years. A deed-in-lieu of foreclosure process impacts the mortgagors’ credit for seven years same as a bankruptcy.
Thus a significant set of families may have no other alternative but to rent. Many investors see this already; that is why there are so many “all cash” offers on bank-owned properties in our area. The prices are so right that most of these properties can return a positive cash flow that only gets better the more you invest.
For example: assume a $400,000 purchase price for a nice 4 bedroom, 2.5 bath home that is in good physical shape needing paint, carpets and similar “wearables”. Assume that the typical rent for such a property would be $2350 per month.
Case #1 – 25% down payment
Down payment =$100,000 Loan = $300,000 30 year fixed rate loan @ 6%
Principal and interest = $1800/mo Taxes = $415/mo Insurance = $75/mo
Total expenses = $2290/mo
Income = $2350 / mo Gross Profit = $60/mo before taxes etc ROI= $720/100000 = 0.72%
Case #2 All Cash Purchase
Expenses = $490/mo
Income = $2350 /mo Gross Profit = $1860 /mo
ROI = 12* $1860 / $400000 = 5.58% before taxes
The only way a Case #1 scenario would prove more lucrative is when you consider the appreciation on the properties and assume that you spread a $400,000 investment over 4 properties rather than one. But what average rate of appreciation would you need to get to make the two cases returns equal?
Assume a 5 year window. Case #1 (assuming 4 properties) earns a total of 3.6% return ($14,400) over the period while case #2 (the single investment) earns 27.9% over the period ($111,600). The four properties need to recoup $97,200 more in appreciation over 5 years than the single property. In other words, assuming all properties appreciate the same, the properties must appreciate at a rate of: $32,400 each over the period or $6,480 each per year. That’s 1.62% average. Certainly an achievable return in most real estate markets of the past.
However, this does consider selling costs. When selling costs (primarily real estate broker fees) are included, the required average appreciation rate for the four property scenario rises to 2.82% annually.
And there is your conundrum, Mr. or Ms. Investor! If you believe the real estate market will hold prices relatively flat for the next five years, a single large investment could pay off better and return significant cash each year along the way. If you think that home prices will accelerate in the next decade, spreading your available cash among several properties will create a better return but only if your realizable appreciation exceeds about 3% per year on average. From this, you can see why many investors today are going “all in”.