Why Do So Many Real Estate Investors Keep Tryin’ To Dribble Footballs?

So far this month there’s been a renewal of callers wishing to talk about locations offering appreciation in value. They couch it in amorphous language, but when the smoke clears, long term or not, they’re wanting to buy properties that’ll go up in value.

I wanna be a 23 years old major league pitcher with an indestructible right arm capable of throwing 140 pitches every fifth day at roughly 97 mph. Oh, and I wanna be able to have pinpoint control with not only my fastball, but my killer curve, and my virtually un-hitable sinking change-up.

I know, I’m bein’ a first degree smart-aleck. But you get the gist, right? Nobody — well, almost nobody, is sayin’ that appreciation can’t or won’t ever become reality again. But there are a couple lines here that’ll need to cross. The line that stretches down the road year after year ’till appreciation returns — and the line dictating when you shuffle off this mortal coil.

We used to say something quite different when we talked about San Diego real estate. Since I first entered the business, it was common to hear the old veterans talk about how if you invested in an investment property today, in 10 years, regardless of the predictable cycles, you’d have experienced a significant increase in value. That was indeed true from the late ’60′s through the the first few years of the 21st century.

Alas, those who still believe that ship hasn’t sailed will suffer the consequences at retirement — that is, if they can retire, having waited for a ship that now lies on the ocean’s bottom.

For the foreseeable future, let’s say the next 5-10 years, it’s more likely you’ll learn to successfully dribble a football than see a rise in your income property’s value in the next 5-10 years.

‘Course that’s just an opinion. My crystal ball is as accurate as yours, right?

I’m predicting a further drop in real estate prices in most, not all regions, and have been since the first of this year. I think in places like SoCal it could be 10% or more, we’ll hafta wait and see. What that means in practical terms is that those who buy ‘at the bottom’ may soon learn, as those who bought in San Diego and places like it in 2007, that prices could indeed continue dropping. I warned them then as I’m doing now. If you’re wanting to buy a home or a 2-4 unit property in which to live, go ahead, cuz over the long haul it’s your home, not an investment.

Please believe me when I tell you, the days of reliable appreciation are over, and for a long, long time.

Think about becoming a west coast investor today. You close escrow in early October, payin’ $250-255,000. Over the next 1-2 years your property loses 8% in value. Now, in order for you to benefit from any future appreciation the property must first appreciate 8.7% to make up for that 8% drop. If after your first couple years the value did decrease by 8%, a credible scenario in my view, it’d take another couple years at 5% annual appreciation just to get you to ground zero — your original purchase price. (20% down payment is assumed here.)

That sequence of events took four years and you’ve gone nowhere. If the market then blessed you with five years of 5%/yr appreciation, your place would then be worth about $322,500. So, in nine years you would’ve netted, before taxes that is, (but after 8% costs of sale) roughly $146,000 from the sale of your property. (That includes the loan balance having been reduced.)

That’s a bit over 11% a year. (I’m using simple math here to make a point.) Sounds relatively OK to better than OK, right? Well, not really. Here’s why.

Those who refused to buy into the hope for appreciation, bought in regions where solid location and positive demographics produced cash flow from Day 1. Think in the example above in San Diego. They made a bit better than an 11% annual return based upon the purchase/sale prices. There was no cash flow. In fact, I quietly assumed they had a break even, which in SoCal is a bad joke when using just 20% down. For those who’ll wanna comment about how they’ve recently done just that, I’m only talking about locations where the investor need not shoot their way in and out of the neighborhood. Minor detail.

Remember: If ya wouldn’t put Mom or Grandma there to live alone, ya didn’t get it from me.

Back to that impressive 11%+ annual return.

Real estate investors currently acquiring income property in areas justifiably known as growth regions, are cash flowing at a 5-10% cash on cash rate annually — with 20% down. Now don’t say it, cuz I can see your wheels spinnin’ away. Wait just a minute here, BawldGuy, 11% is 11% no matter how it’s sliced, right? Yeah, but at this point we should discuss how in the real world sometimes one man’s 5-10% beats another man’s 11% eight ways from Sunday.

It’s all about doin’ things on Purpose, and with a Plan.

The guy choosing San Diego or pretty much anywhere else on the west coast, is gonna hafta put at least 30-40% down payments just to break even in good areas. For instance, those banks who lend to self-directed IRAs and Solo 401Ks? They won’t even talk to those who wanna invest in California unless they’re willing to put at least 50% down. Still, let’s disregard reality for the moment, and say 20% broke you even.

So what?

The investor who bought the cash flow property is applying that cash flow each month to the reduction of the loan balance. Let’s look at how they fare over the years. I’m assuming no increase in value for the cash flowing property, or any increase in the net operating income whatsoever over the entire holding period.

In the first example our San Diegan realized an 11%+ return annually after nine years. We assumed they lost 8% in value the first couple years. We’ll assume the same for our cash flow investor to make it fair. It’s irrelevant, but we’ll do it just the same.

In nine years the San Diegan’s fantasy property (Sorry, couldn’t hep myself) has a loan balance of $170,100. The growth region/cash flow investor has a loan balance of just $115,000.

Oops — seems a few hundred a month of ‘meaningless’ cash flow has increased our growth region investor’s equity by roughly $55,000 over his San Diego counterpart.

Let’s fast forward 7 years and 9 months later, OK? (This is fun.)

It’s now been 16.75 years since these two investors made their respective choices. Let’s look at how they each fared.

The San Diegan now owns a property with a loan balance of approximately $127,600 or so.

The other guy? He doesn’t owe one thin dime. His cash flow is well over $1,500 monthly at this point. The San Diegan? He’s still thrilled his property is breakin’ even.

Remember, we allowed for no appreciation in value or net operating income. But if we allowed the San Diegan to increase his NOI by half over the 16.75 years? He’d still only be cash flowing about $560 a month — a far cry from the $1,500 our growth region guy enjoys. Further more, unless he takes a page from our cash flow dude, he’s still gotta wait almost 14 more years to be free and clear.

Bottom line?

The cash flow investor in this example has a gross equity of $250-255,000 in 16.75 years — without dollar #1 of appreciation. His capital, not counting any cash flow, grew from about $55,000 to say, $252,500. That’s an annual capital growth rate of 9.5% — again, without any appreciation whatsoever.

BawldGuy TakeAway: If you own property in San Diego, or pretty much anywhere on the west coast, please, I beg you:

Get Outa Dodge Now.

Take your investment capital and/or your current net equities in local income properties and put them where they’ll actually produce the results you wanted in the first place.

Stop tryin’ to dribble a football. It can’t be done. So why do so many keep tryin’?

Let’s talk about your situation, OK? What’s your plan? Gimme a call at 619 889-7100 and we’ll figure things out together. Come on, I need a fix. Have a good one.

Related posts:

1. California Real Estate Investors Using 1031 Exchanges To Turbo Charge Portfolio
2. How Real Estate Investors Really Get It Done – Attn: Newbies
3. Real Estate Investors – Learn To Make Time Your Friend
4. San Diego Real Estate Investors — Pay Attention To Jon & Jill
5. Real Estate Investors — Is Your Addiction To Cash Flow Lowering Potential Retirement Income?