Seeking Truth? Or Seeking Support For Your Position?

I’ll begin this post by pleading guilty to what follows. It takes one to know one. Learn from my experience — regardless of our will to control — things change. We can either go with the flow and benefit from the new paradigm — or suffer the consequences.

People are funny. We wanna do something. We don’t know for sure whether it’s the right something — but we know for sure we wanna do it. It’s kinda sorta reverse science. Instead of offering an hypothesis followed by attempts to test the hypothesis, they instead look for evidence — however thin or out of context — to support their position. I know this to be true, because sadly, I defended San Diego investment property a year or two beyond what the empirical evidence supported. I was simply blinded by decades of experience and blind to the changes happening before my very own baby blues.

Some real estate investors are so ensconced in their incredibly underperforming investments — they refuse to see the evidence demonstrating the error of their ways. I used to be one of them. Here’s what we did at our meetings.

In markets like we see in California, i.e. very expensive, real estate investors now find themselves owners of income property offering everything but — competitive capital growth and no negative cash flow. Yet they’ll talk ‘tlll they’re blue in the face defending their decision to remain. The status quo is just too comfortable, and the option to change just too much of unknown for them.

I’m not judging here, as I did the same thing myself. I probably should’ve left San Diego two years before I did. It finally came to the point where I could no longer defend San Diego numbers. I did what people are still doing today. It boggles the mind — but since I did it too, I’ll not cast stones. Here are some of the pieces of ‘evidence’ the ‘stay local’ crowd proffers.

I can drive to the property

Property in San Diego, Orange County, L.A. Palo Alto, etc. is always in demand

Rents just never stop goin’ up here

40-50% down to a break-even makes sense with superior appreciation

There are still investors out there impervious to significant negative cash flow

Absolutely no ‘outa state’ location is nearly as cool as mine

I got out in late ’03 — advising all my clients to sell San Diego and Get Outa Dodge.

San Diego property values have been dropping since late ’05. Same for Orange and L.A. Counties. Palo Alto? It’s a paradise on earth. If you haven’t been there, it’s difficult to describe. They don’t live in our world, not even close. Everyone is a six figure wage earner, an MBA or Ph.D, and have kids literally playing in competitive organized chess tournaments — at four years old. Simply put, Palo Alto lives up to its press clippings. We loved it there. What a gorgeous place to live.

But…

Many investors find themselves with rentals costing them $2,000 a month to own. That’s almost $25,000 a year in negative cash flow — and it’s not the exception to the rule. Also, it makes no sense to endure negative cash flows just because you can. The idea is to end up with the most capital gain possible, right? Right.

Several investors this weekend told me first hand — buying Palo Alto income property requires 40-50% down just to avoid negative cash flow. Wow.

Do the numbers, they’re easy. If you can buy 4-5 times the dollar amount of property with the same exact capital, the more leveraged property only has to experience 20-35% of your ‘superior’ area’s rate to keep up. Ask yourself…

But before you ask yourself the next question, ponder the following.

Pause — See a recurring trend here? When is a banana not a banana? Uh, what? What’d'ya mean it’s not an apple — it says ‘apple’ right on it — are you blind, oh Bawld One?

OK, back to the next question.

What if you executed a tax deferred exchange into 4 times the property and experienced 1/3 the appreciation? Confused? Don’t be — let’s look at the dollars, cuz that’s what we deposit in our bank account, right?

For this example we’ll use $400,000 (40% down payment) as the original capital invested into the ‘superior’ area’s $1 Million property. Compare that to using the same capital amount as 10% down somewhere outa state.

We’ll use 15% appreciation for ‘Premium area’ and 5% for ‘Outa State area’.

15% X $1 Million = $150,000

5% X $4 Million = $200,000

The so called ‘inferior’ region produced a capital growth rate of 50%. The gold encrusted ‘super region’ just 37.5% — and the difference will only become larger with each passing year. In terms of dollars, the outa state investor is already ahead a cool $50,000 the first 12 months.

Now, compound that over the next 15-30 years, and you’ll begin to get the big picture.

Here’s another pragmatic thought to ponder.

Your income property, located in paradise already requires 40-50% down just to avoid negative cash flow. Even if your stuff does appreciate 15% annually for the next 3 years, what Einstein is gonna pay you $1.5 Million for a property which by then will surely require 50-60% down?

Or…

Say you find a buyer — you gonna take your net proceeds and buy a $2 Million single family or duplex rental in the same area? Really? At least while you’re alone, be honest with yourself and come to at least one supportable conclusion. And what is that?

In 3 short years the outa state investor has already taken a 6-figure lead on capital growth in terms of dollars. What’d'ya think it’ll be in 10 years? 20? 30?

Please — wave the white flag — yer killin’ me.

Related posts:

1. Walking the Talk: BawldGuy Gets You Outa Dodge With Minimum $10,000 Discount
2. San Diego Real Estate Investors — How’s That Income Property Workin’ For Ya So Far?
3. San Diego Real Estate Investors — Some Reasons to Invest Out of State — Try Texas
4. Your Retirement: Financial Position Above the Poverty Level?
5. The Learning Curve of a Recovering Attorney Turned Real Estate Investor — Escaping From Dodge