Sunday, September 10, 2006

Yes, You CAN Lose Money in Real Estate

by Osman Parvez


Beware, the following article contains graphic descriptions of painful investment carnage. reader discretion is advised.

It was suggested that the little investment analysis at the end of my Superior Market update deserved its own post. So I took a little time to analyze it further.

Here's we go ...

1643 Egret Way has been on the market for 317 days (as of 9/09/06). It's a 2 bedroom, 2 bath condo with a 1 car garage. Originally listed at $194,900, it hasn't seen a single price reduction and yet the seller is described as "very motivated."

Hmm...

On the listing sheet, it's also described as "a great first time investment property."

Given the length of time it's been on the market, I first looked at this condo because I thought it might be a good candidate for a low offer. You'd be surprised how even the most stubborn sellers become more reasonable after their property has been on the market for 300+ days.

Then I looked at the ownership history.

The condo first sold in July of 2001 for $192,000. It sold again in September, 2003 for $189,500. That's right, $2,500 less than three years earlier. Today the seller is asking $194,900 which represents less than 1% annual appreciation from the purchase price in 2003. Given inflation over the last few years has ranged from 2% to 3%, this property lost value (again). And that's before paying real estate commissions.

Ouch!

Ok, what about cash flow?

In September, 2003 the national monthly average for 30 year fixed rate mortgages was 6.29%. If the owner put down 20% and qualified for the average rate, his mortgage payment would have been $937.37. Add on $199.00/month for HOA, $117/month for taxes (taxes are ~$1,400/year), and for easy math $50/month (600 per year) for insurance. Since even condos require some maintenance, throw in another $50/month. Add it all up and the carrying cost would have been $1,353.37 per month.

I don't track the rental market, but I seriously doubt a 2BR, 2BA condo in Rock Creek is renting for $1,350 month. Perhaps $900 to $1000?

What about your tax savings and how did it compare to renting?

The interest on the mortgage is tax deductible (for primary and secondary residences). Using a mortgage calculator (i'll check the math later), you would have run up $28,106 in interest payments in the first 3 years of ownership on a 6.29%, 30 year FRM with no points. If you're at a 28% federal tax bracket plus Colorado's income tax of 4.63%, you should be able to save $9,171 on your taxes over three years.*

Renting probably cost ~$350/month less than buying the property, so after three years (assuming no rent increases), buying was $12,600 more expensive than renting. Even offset by the tax savings, buying this property three years ago would have cost you $3,428 more.

So let's see, this property appreciated at less than 1% per year which means it lost value (in real terms when you consider inflation of 2-3%). If you were a landlord renting it out, it probably didn't cash flow costing you an additional $350/month. If you were living in it, you probably could have saved ~$3,500 by renting instead plus you skipped the headache of maintenance. You also haven't been absorbing the time/cost (300+ days and counting) of trying to sell it.

Lesson? Don't let anyone tell you that you can only make money in real estate. It's not always the case, but from an investment perspective, this particular property was a lemon.

If you're thinking about buying property, let this be a reminder for why it's important to look into ownership history and market trends. And if the listing agent tells you it's a "great investment," be sure to double check the math.

Another thing to consider is holding period. As I mentioned to clients just the other day, 3 years is a short time. For investment purposes, I'd recommend holding for 5 years or longer. In the case of Superior, companies like Vail Resorts are also driving down the vacancy rate in nearby Interlocken. As more businesses take up residence, more workers may be looking for housing with a short commute. The rental market will probably improve in coming years.

We analyze the market and publish our monthly updates to help buyers make intelligent decisions about real estate. With average area appreciation rates, most properties haven't performed as badly as 1643 Egret but it still pays to do your homework before investing. If you'd like to talk to us about your real estate investments, feel free to contact us at ph: 303.746.6896.

*assumes that you paid no points at closing for the mortgage, that you qualify for a home interest deduction, and that you itemize your taxes on schedule A of your Federal tax return. Total tax savings may be less for higher incomes that have their allowable itemized deductions phased out. Your total tax savings may also be reduced if you prepay your loan.







----

Like this analysis?    Subscribe to our client research report.     
Want to get blog updates via email?  Click HERE.       
Ready to buy or sell?  Schedule an appointment or call 303.746.6896. 
You can also like our Facebook page or follow us on Twitter.

As always, your referrals are deeply appreciated.  

--
The ideas and strategies described in this blog are the opinion of the writer and subject to business, economic, and competitive uncertainties.   We strongly recommend conducting rigorous due diligence and obtaining professional advice before buying or selling real estate. 

5 comments:

  1. Heck yea! I lost ALL MY MONEY AND ASSETS in the California real estate crash of 1991. There appeared to be no end to the easy money. Optimism prevailed as I lived beyond my ability to earn. I moved to the country for the good life, only to be surrounded by folks with mental health and drug problems who found cheap rents there. It became impossible for me to sell my depreciating asset, so I gave it back to the bank. We are in for a lot of personal pain as a nation built on debit and entitlement. America has become a spoiled selfish child who wants everything but is unwilling to do anything for it!

    ReplyDelete
  2. Wow, sounds like you were way in over your head in 1991. When did you get back into real estate or have you stayed out since then?

    ReplyDelete
  3. By the way, this article has been added to my research archive.

    ReplyDelete
  4. There's also the 6% or so that goes to the realtors, unless they're FSBO.

    ReplyDelete
  5. Tips for Being a Successful Landlord

    In today’s apartment rental market there are several things that are “must do’s” for becoming a successful landlord. The reason you’re playing the real estate rental game is to have the check in your mailbox on the first of the month, right? Here are a few tips that can help you to achieve this with as little aggravation and frustration possible.

    First and foremost is finding the right tenant to rent your apartment, house or other rental. This is the most important ingredient in the recipe. Checking the prospective tenant’s credit history to make sure they are paying their bills is one of the best ways you can screen. A tenant that pays their bills on time most likely will send you their rent on time. Establish a clear system on collecting rent, handling complaints from the tenant and how you will contact them if you need to gain access to the apartment.

    Secondly, get all the important terms of the tenancy in writing. You have the option to have a basic rental agreement or draw up a formal lease. Whichever you decide, the important thing is to document the terms that you and the tenant agreed to. Clarify who is paying the utilities, the rental price and any other agreements made between you and your tenant.

    It’s a good idea to stay on top of the repair and maintenance needs of your property. When you are notified of something that is broken or not working, repair it as soon as possible to prevent further damages. You may also lawfully enable the tenant to withhold rent, sue for injuries caused by defective conditions or move out without notice.

    On a similar topic make sure you are carrying enough property and liability insurance to cover yourself in any situation. A well designed insurance program can protect your rental property from losses caused by everything from fire and storms to burglary, vandalism, and personal injury lawsuits.

    I hope that this has been helpful to you. Just remember, as long as you follow these simple tips you will be on your way to a happy and fulfilling landlord future. Best of luck!

    ABOUT THE AUTHOR: Eric Goldstein, associated with www.AllSpacses.com which Conveniently Connects All People with All Spaces in All Places, has been dedicated to the real estate rental market for over 8 years. He has assisted over 25,000 landlords with their renting needs. Any questions about renting apartments, houses or other rentals feel free to visit www.AllSpaces.com or email him at Eric@AllSpaces.com.

    ReplyDelete