Extreme Houston exurbs as an attractive cash flow play?

Question

Hi,

I am considering investing in my first rental buy-and-hold property here in Houston. I live in the Houston suburbs so naturally started looking here first. With the market recovery, it seems most of the properties in my area aren't likely to cash flow, but I believe I may have found a few houses even further away from Houston (in the "exurbs", should not be considered "suburbs" given distance from downtown) which may meet my requirements. Below is the investment thesis, and the high-level numbers. I would greatly appreciate some feedback and thoughts from the BiggerPockets community to see if this truly is an attractive investment or just a mirage.

Investment thesis

• Several manufacturing facilities moving into area, projected to create thousands of new jobs over next 2-3 years
• Little apartment supply close to these facilities currently, plans for 1-2 complexes to be constructed to meet expected demand but likely not enough, with SFH's needed to fill the gap
• Very low home prices compared to most of Houston given distance from downtown (30+ miles out)
• School ratings are mediocre currently but expected to improve as several new MPC's expected to build out adjacent to these houses, with much higher price points
• Potential to generate decent rental income currently, and potential for significant rental rate increases and house price appreciation as 1) Jobs continue to be created, 2) Schools slowly improve, and 3) Retail development picks up
• From personal standpoint, low price point attractive for my 1st investment property as it reduces upfront risk and allows me to enter with less financial resources

High-level numbers

• ~$140K purchase price for 3 bed 2 bath house (less than 5 years old)
• Total monthly payment of ~$1,000 per month for 30-year conventional with 20% down (including tax, HOA, home insurance) should be ~$1,000 per month
• Expected rent is $1,300 to $1,400 per month (based on comps of similar homes around area)
• With expected 80% vacancy rate (being conservative) + repair costs + time and effort spent doing property management (will do it myself), expecting to break even from cash flow basis in Year 1, with anticipated increase in rent allowing me to generate positive cash flow starting from Year 2
• Assuming 3% housing price appreciation per year, and an exit in 10 years, expecting 12%-14% IRR

Anant Lal · Answer

If you're 30 miles out from Houston, I'm guessing you're talking about somewhere like Richmond/Rosenburg/Mont Belvieu/Rosharon?

1) Are you planning on self-managing forever or giving it to property management in the future? I planned on self managing, but then I had to move away for work. I also discovered I'm a terrible property manager, and I turned it over to someone who hopefully knows how to run it a little better than I do. You force yourself into a hole if you don't account for property management upfront.

2) I don't think you can assume 3% housing price appreciation per year. A lot of the chatter I'm hearing is that winter is coming for a few reasons.

A) The fed is increasing interest rates which leads to lower housing prices (as peoples payments go up, they can afford less house).

B) Markets are cyclical, and we're close to the longest we've ever gone without a downturn. Even if prices don't go down and we don't enter a downturn, you can't assume that there will be sustained 3% growth. Nationwide, there hasn't been 3% inflation in nearly a decade. Will the deal still make money if you don't have appreciation, or a have lower rate of appreciation?

3) Rents may or may not go up. Even if they do, it may not be enough to cover the big capital expenditures. Your risk on this probably depends on how long you plan on holding these houses.

4) Have you accounted for all selling costs in your IRR? There's more than just the 6% seller fee. Taxes (on your capital gains from 3% appreciation per year), Title.

5) How are you doing your IRR calculations? It seems to me like you should be getting more than just a 12% IRR assuming 3% appreciation per year. Assuming you break even everywhere else, 3%/20% down payment gives you a 15% return. Between principle pay down, depreciation + mortgage interest on your taxes, cashflow, and everything else you should be getting more than just the basic 15% you're getting from appreciation and leverage.

There's some decent chance of an upside, but its risky to be counting on there being appreciation in the area. If the deal can't sustain itself as it currently is long-term, then I would stay away. There isn't enough potential upside (I would want more than 12% IRR for a speculative appreciation play) to take on the potential downside, but that's just me.

Alfie Park · Answer

@Anant: Your points about accounting for the management expenses (even if I do it myself) is valid and would further reduce the COC return and IRR. Also other costs like tax and title would reduce IRR as well.

I was doing the IRR on before tax basis since my alternative investment outlet is the stock market and capital gains there are taxed at same rate as capital gains from real estate.

You are right that if I buy and hold for 30 year duration then I should get 15% return minimum with the 80% leverage and the 3% appreciation. But I was assuming a 10 year holding period here which reduces the IRR below the 15%.

@ More generally, I decided not to pursue this deal as I realized a couple things:

1) I asked some folks involved with the manufacturing facilities where newly relocated coworkers chose to live and realized these workers are actually buying in established communities in nearby suburbs (i.e. inside the Grand Parkway 99 loop) instead of moving out to the exurbs closer to their work.

2) Existing zoned schools are admittedly not great at present, and future plans of close-by MPC's won't get to the areas I'm looking to invest for another decade or so. Too much time waiting for schools to improve for my risk tolerance

But it was great to get all of y'all's input. I'm looking to invest now closer to where I live (actually in my own master planned community), which already has great schools, rapid retail development, and still affordable prices.

Tommy Hopkins · Answer

Hi Alfie, I think you may mean 80% occupancy (20% vacancy rate). Hard to tell what the future will bring in terms of appreciation.

Extreme Houston exurbs as an attractive cash flow play?

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