How valuable to your retirement is your favorite market? Oh, sorry, did I hit a nerve with that one? You may very well be sacrificing a few thousand a month in retirement income. Oh sure, NOW you’re payin’ attention.
Transcript: Hi this is Jeff Brown the “BawldGuy”. Today we’re going to talk about our favorite real estate investment market. You know, the one you love the best. It has everything you like. Not. But you say it does, because it’s the one in which you live. While defending your choice, all that typically happens is you gloss over the shortcoming you know are laying there for all to see. We all do it. I did it. Let’s look at my local market as an example: San Diego, over a decade ago, I threw in the towel deciding never again to put a client into San Diego investment property. That’s a big decision to make. The only thing it had going for it back then is the same thing it has now: great weather. There is never any snow damage in San Diego, right? The summers aren’t 100 days of pure hellish agony either, which means the heaters and air conditioners in the rental units last a lot longer than in much of the country. That’s about it on the plus side of the ledger there. Look, back when I made that decision, a typical San Diego duplex, in even a boringly average neighborhood, sold for roughly $550 to $650,000. The annual gross rent you receive for that is a princely sum of around 30 to 32 grand, give or take a grand. A young duplex was under 35 years old. Garages? Some did. Most didn’t, or what they offered was pathetic. The floor plans were, for the most part, obsolete. How about kitchens without dishwashers, or anywhere to put them? Suffice to say, as an investment, they’d become bad jokes. But San Diego-ans are used to them. Houses in San Diego? They make two to four unit properties look downright golden. “But Jeff, what about now after the bubble? Aren’t things more improved?” That’s a good question, and the short answer is yeah, but not enough to make a hill of beans difference. What would you think of me if I advised you to invest in a duplex or a four-plex built in 1952 with all the above wrong with it? Would you pay 380 grand for 30 to 32 in gross annual income? With floor plans and kitchens that were frowned on by tenants a generation ago? Your tenants would be far inferior than in other markets out of state. How bad is it? In San Diego I’ve seen for the first time, tenants now showing a preference for apartment living over duplexes and four-plexes. Historically, there has always been a strong segment of the renter population that preferred yards. They wanted neighborhoods with more houses than apartment complexes. Now, given San Diego’s dirth of young modern inventory in that housing segment, tenants have for years been turning their noses up at the old, functionally obsolescent two to four unit inventory. Nobody wants to live in Grandma’s house. Now, what this means, in a nutshell, is that the two to four unit owner is and has been for quite awhile, stuck with much lower quality tenants than they would like, and there’s not much of anything that they can do about it. Let’s go to the numbers now in order to really paint the picture clearly and see why I left this market over a decade ago. To illustrate it a bit more dramatically, I’ll allow the San Diego duplex to claim a 40% expense and vacancy cost. That’s 40% of gross scheduled income: GSI. On the property I’d recommend, we’ll impute what I’ve come to call the Murphy Spreadsheet. Simply divide the GSI by two. We’ll use five and three eights percent fixed interest rate with a 30 year amortization. That’s today’s rates, ok? San Diego’s duplex will sport a net operating income of $19,200 a year. Mine, out of state, will be simply dividing the GSI by half, so I will just be 16 grand a year. Now let’s take a look. San Diego’s price: 380, my out of state price: 280. Here we go … San Diego’s duplex, using the lender’s requirement of 25% down payment, gives your happy investor annual cash flow of about $49. Happy feet dance! We’re going to Sizzler, right? Now, my out of state duplex has an annual cash flow of $1,890 a year. Remember now, we were Draconian with the vacancy rate and operating expenses on this one to make a point. Not to mention, it’s brand new, so 50% expenses in ludicrous, but we’re making a point here. Even when we piled on mine with the Murphy’s Spreadsheet, it would break even. Every month I turn interest rates with just 15% down. Don’t get me wrong, I’m not recommending that. No way! The point is that the rent/price ratio is solid enough to still pay for itself with as much as 85% financing. That works for me. Those are the numbers, but what about all the other factors we need to take into consideration with any acquisition analysis? That’s what matters: the whole picture. Though I wouldn’t think of putting Mom into the San Diego property to live alone most of the time, I’d not hesitate with the out of state duplex. San Diego is almost eligible for Social Security with their units, while good old out of state is brand spanking new. San Diego has two bedroom, one bath; three bedroom, one and a half; shared or over-sized one car garage, and both sides of mine have regular size two car garages. The kitchens in mine are state of the art; ceilings are ten feet, not the California eight; each side is three bedrooms; two full bathrooms, including one in the master bedroom. Did I mention the master also sports a walk-in closet? Also, mine have their own laundry hook-ups, which is only a dream for the San Diego duplex. Keep saving your quarters, dude. Yet the majority of San Diego’s real estate investors will still say it’s their favorite market. Objectively, it simply cannot be supported. What they really mean is that they are familiar with the neighborhoods, and they can drive by them any time they feel like it. Whoop-dee-doo. What I generally ask them when they bring that up, as if it’s some sort of universally effective trump card, is how that’s been working for them lately. It’s usually about at that point in the conversation that it tends to get a little quiet. Look, I didn’t abandon my own local market on a whim. It turned my life upside down for almost two years. The analysis says what it says. My local market was significantly inferior to other options in different states. I owed it to my clients to make the move. Ask yourself: “How much of a reduced income is it worth to you to be able to drive by your old, functionally obsolescent income properties when you’re retired?” Yeah, I thought so. I sure hope this has helped you to focus on what matters. This is Jeff Brown the BawldGuy, I’ll catch you next time.