Stockton CA Multi-Family Bids Adieu to 1% Rule Properties
For the last few years Stockton CA buy-and-hold rental property used to be a virtual no-brainer. Now the market for conforming multi-family property is at a turning point, breaking through the floor dictated by the 1% rule. And that is very bad news for new investors looking for multi-family property. Here is why:
The Stockton cash-flow rental market has been my primary (even sole) focus for over three years now. This means I have been keeping a very close eye on, what I call, "conforming" multi-family rental pricing. By this I mean standard duplexes and triplexes build in the last two or three decades of the 21st century. Throw a dart at a map anywhere north of Hammer Lane and you are bound to hit one of these properties.
Having seen owned and rehabbed a good number of triplexes and duplexes that fall into this category I have really come to love this property "class". Why? Because I am lazy and unimaginative. And I know it:). Let me explain. These conforming multi-family properties are extremely predictable; everything is very "cookie cutter". If you've seen one, you've seen them all. Their homogeneous nature makes everything from estimating repair costs, guesstimating rents and even finding tenants, a lot easier. No need to reinvent the wheel.
Figure 1: North Stockton is Cookie Cutter Central:).
Also, being "newer" all building techniques used in their construction are standard and pretty "modern". This makes it straight forward to work, or have work done on these properties, even by less than expert craftsmen... Finally because these properties have always been rental properties. This means that while they are often badly maintained, at least they typically don't contain weird DIY modifications. What you actually mostly see is no upgrades at all:).
Combine the above with some basic, common sense knowledge about the different neighborhoods, or should I say blocks, this is Schizophrenic Stockton after all, estimating what you will be able to get in rent for these properties is also fairly predictable.
For all the above reasons these types of properties are definitely what I would recommend to new out-of-town investors looking to get their feet wet.
And that brings me to the bad news: The price point of this type of property is structurally starting to breach the 1% rule. Duplexes that will rent for around $900*2 ($1800) are being sold for over $200K. Triplexes that reasonably will not get more than $800*3 ($2400) are being offered for close to $300K.
Why is this such bad news? Owning a good number of these types of units I have discovered that because all properties are so similar, the 1% rule is dead on for this property type. Unless the building is inparticularly bad shape, needing immediate rehab; in a really bad location, or has rents that are even close to market, 1% of purchase price is about the minimum you need to gross to make the property a reasonable cash-flow investment at the current interest rates.
Without expounding too much on my (pretty standard) calculations, I want to point out that when calculating the profitability of a property I assume 100% financing at current rates. Now of course, the beginning investor will probably put 25% down. However, even if you do pay down (and I do recommend doing that), I feel your calculation should account for the opportunity cost that you incur by locking up those funds. Just think of it this way: you could have been doing something else with that cash. For example you could have paid down your mortgage or put the money in a Dow Jones Index fund etc. No money is every free.
What does this mean for the Stockton rental market? I think the days of abundant, no-brainer cash flow deals on the MLS have come to an end. Investors looking for cash flow will be tempted to look at old, non-conforming, functionally obsolete C and D class properties. However based on the low predictability and possible complications that these properties offer few would consider these good "starter" investments.
What I think we will also see more and more is money flowing into the market from Bay Area professionals with high paying jobs. I like to call these "dentist-investors":). This type of investor is looking mainly for tax deductions as opposed to short term cash flow. of which after all,they already have plenty:). Their hope is to have some paid-off properties by the time they retire. This allows them to slowly liquidate their portfolio or continue to collectrent without paying interest, when they are in a lower tax bracket.
Exactly because they are not looking for immediate cash flow. These investors are very hard to compete with on the open market. After all, if you need to cash-flow to sustain and grow your portfolio you don't have the luxury to wait 30 years until your mortgage is paid off...
Sowhat is my advice for new investors that are just now thinking of entering the Stockton market? Frankly, I don’t think there is any simple straightforward solution. If you know one, let me know too!:) So since I can’t tell you what to do I thought maybe I should close by telling you what *not* to do.
First of all, don’t pay a price because everyone else pays it. Analyze your deals very carefully from a cash flow perspective. If other conforming duplexes are selling for $230K this does not make a $210K duplex a great deal from a cash flow perspective!
Unless you want to speculate on equity growth, or you are one of the before mentioned extra-long-term-dentist-investors, I would not recommend breaking the 1% rule on conforming multi-family unless you have a very clear idea of how you will add value to the property to make it meet the 1%. Don’t give in to wishful thinking (“I’ll rehab real nice and raise the rent to $1,200 per side…”).
If you are thinking of adding value by rehabbing property, please realize that Stockton is a market with a very high price-elasticity. Unfortunately rent price seems to be way more important than quality for most tenants. Also consider that if you invest $10K and raise the rent by $100 you have not improved your gross rent multiplier at all. You just managed to increase your exposure with $10K while preventing yourself from putting that cash to use elsewhere.
Whatever you do, remember that in a tougher market you make or break your investment when you buy it…
Anyway; those were some of my thoughts musings and opinions on Stockton investing. Let me know yours! Also if you have any questions regarding Stockton multi-family feel free to ask, I’d be happy to help!