How to get a 13% cash on cash return in Stockton

26 Replies

@Billy L. and several others have asked me why I like the Stockton market, so I figured I'd share my perspective on the market and an example of how I achieve a 13% cash on cash return. I'd love to hear your thoughts. 

Stockton was hit hard during the great recession and is still recovering as of summer 2015. It had the honor of being the most populous US city to file Chapter 9 Bankruptcy at the time (2012). It's now getting a boost from a slowly but surely improving local economy and a quickly improving Bay Area economy. Despite the progress, Stockton still has a long way to go. I think its colored history and incessant bad press scare a lot of investors away. I love that because it means less competition. I live in the Bay Area and many real estate investors here won't even consider Stockton. They think it's too risky.

While I do believe Stockton real estate values will continue to appreciate, that's not my primary motivation for being in the market. I like it for the strong cash flow and what I believe to be relatively low risk. I should caveat here that my strategy is to offer the nicest single family rental available in a Class B neighborhood. This allows me to attract what I believe are the best tenants in the area to nearly every property I own. Great tenants treat the property well and require less hand holding than average tenants. They can also afford to pay slightly more and are more likely to pay on time every time. 

Most markets in the Bay Area won't come close to cash flowing the way Stockton does; real estate there is way too expensive. While Stockton may not yield numbers like you might find in Memphis, it can provide strong cash on cash returns with relatively low risk. 

Let's consider an example. In the spirit of transparency, below are real numbers for 2014 for a duplex I own in Stockton. I was fortunate enough to purchase this property with zero money down, but let's use a 25% down payment to illustrate what the cash flow looks like with a more traditional purchase. 

Purchase price: $160,000

Down payment: $40,000

Loan: $120,000

Monthly Income

Rent: 1,755


Monthly Expenses

Property tax: -196

Insurance: -64

Yard: 0

Prop Mgr: -140

Vacancy/Maintenance: -170

Garbage: -35

Water: -120

Net Operating Income: 1,030/mo. (12,360/year)

Debt service: -588

Cash flow: 442/mo. (5,304/year)

Cash on cash return: 13%

A couple notes on the above. Property tax is a bit high and was recently assessed downward by the county at my request and after providing some documentation. We opted for a no maintenance yard which eliminates the normal monthly expense for mowing, edging and blowing. I like doing this on a property whenever possible. I have a property manager for this particular property because the tenant profile is slightly below what I am comfortable dealing with myself. (Even if I manage the property myself, I include the expense as a line item when calculating my return). Water expense is high (which reminds me I need to do take some action to lower it!). 

Bay area investors - I'd love to hear your thoughts!

Matt

@Matt Shamus

  you would be surprised your numbers are as good if not better than Memphis given the tax burden and the bad debt or trouble collecting rent.. Although to be fair to Memphis if you had a home renting for 1700 a month that would be an A class tenant

@Matt Shamus what do you call a no maintenance yard? Is that like a rock garden with desert plants or just plain concrete and basketball hoop? 

Thanks.

Matt, 

Those are some pretty sweet numbers. I'm a new investor from the SJ area looking in the central valley area up to Sacramento for some decent cash flow as well. Real quick, on the property you mentioned, was that pretty much turn-key? I noticed there were no rehab #s in there. 

Thanks,

Aldwin

@Chris E. in this case the yard is mostly dirt, and there isn't much of it. Although I wouldn't do this most of the time, the neighborhood in this case support it. The tenants actually planted a nice garden so they appreciate it. 

We are in a pretty severe drought here in CA so eliminating the need to constantly water grass just feels like the right thing to do. Plus, creating a no/low maintenance yard increases monthly income by reducing expenses. I usually go with weed cloth, high quality bark and drought tolerant plants. River rock with some select trees also looks nice, dependent on the property. 

Sounds good. Thanks.

@Aldwin De Torres this property was pretty much turnkey. Tenants were in place in both units and there wasn't much deferred maintenance. The property was built in 2002. 

That said, we had to evict one tenant pretty much immediately which was pricey. The previous owner was OK with this tenant paying late constantly and didn't provide any real incentive for on time payment (e.g., I wont evict you!). 

The unit was in rough shape so there was some cost for new carpets, deep cleaning, new toilet, etc. It was on the order of $2k. 

Great numbers and very impressive, well thought out and easy to follow analysis - I love it!

My "concern" (if you could call it that) would be around the economy of Stockton (i.e employers there, what the growth potential is, how will an investor get appreciation in their investment) - but, for a pure cash flow investor, comparing it to the Mid-West with similar concerns; I'd say this is a fabulous region to consider. 

I like your thinking around finding somewhere that many investors are afraid of / don't want to go to, and turning it into an opportunity.

Well done and thanks for sharing this!

@Matt Shamus How long have you had the property and how much history do you have on your actual expenses? I'd be surprised if your vacancy and maintenance combined are only 10% for the long haul.

Matt Shamus I agree with Mike that something is off in those numbers. Here's my breakdown with a 20% down 30'year mortgage. Purchase Price $160,000 Rent INCOME $1755 EXPENSES Vacancy (10%). $175/month Property Management (10%) $175/month repairs (10%). $175 /month Taxes $3000 (guesstimate) $250/month Insurance $60/month Mortgage $687/month NET CASH FLOW = $242/month Cap Rate 6.9% Cash on Cash 6.9% Everyone has there own way of Crunching the numbers. Stockton doesn't look good for me the way I do it. I just want to throw out there another perspective on things.

@Matt Shamus great write up, thanks for sharing it. Do you prefer duplex over SFR in Stockton? My concern with Duplex is I have joined an investment group who specialized in renting out duplexes in Vegas and the feedbacks we got back are tenant quality is typically lower compare to SFR, so the turnover rate is higher. It's a different market, not sure how applicable it is in your case. What's your feeling on that? Does SFR offers similar ROI in Stockton?

@Mike D'Arrigo approaching two years ownership. As I mentioned the property is a relatively new build so maintenance has a low baseline. Vacancy is definitely an estimate and it's possible that could push these expense numbers higher over time. But I have not seen that in my first two years of ownership. I like keeping rent at slightly below market to maintain tenants for a longer time and limit the amount of times a unit turns over. I also work very quickly to clean and perform any necessary repairs when a tenant moves out to limit the amount of time the unit is sitting vacant. 

@Account Closed I have not been able to find a lender willing to go to 80% LTV on a duplex. Based on my experience 25% down for this kind of property is more likely. Your expense numbers are very conservative and are pretty good for a back of the envelope analysis of a potential deal in Stockton (if you don't have legitimate expense figures from a seller). I like your approach of estimating conservatively and I do the same.

My numbers above are actual from 2014 and they have been consistent since I have owned the property. 

@Billy L. all else equal you're probably going to see higher cash flow with a duplex, but lower appreciation potential and fewer exit strategy options. In my experience SFRs in Stockton will have slightly lower cash flow but greater appreciation potential and will be easier to exit. 

Good write-up @Matt Shamus

I also invest in Stockton so I'll share some of my numbers to show yours aren't an anomaly and to hopefully answer some of the questions raised about vacancy rate and appreciation. 

I'll use examples of two SF houses I bought back in 2013.

One was purchased for $94k, and I put about $21k into it ($115k total). It currently rents for $1075/mo (which is under market). I recently had it appraised for $180k when I took a $100k HELOC out on it.

The other was purchased for $110k, and I also put about $21k into it ($131k). It currently rents for $1195/mo. I recently had it appraised for $185k when I took a $110k HELOC out on it.

The actual vacancy rate on both houses for 2013, 2014, and 2015 has been 0%.  However, to give a better idea of the local vacancy rate, I ran the numbers on all of my properties during that same time period and found that it averages 2-3%.  (I budget for around 8% vacancy but have never had it that high as the rental market is very strong and I usually find renters within 1-3 days of having a vacancy.) 

I self-manage my properties and don't pay any utilities (i.e. no water/garbage, no gardener, nothing).

I've challenged my assessed property tax values before when I felt they were too high, and I've always succeeded in having them lowered (because I had substantial documentation supporting my position).  However, overall, I find the local property taxes to be very reasonable (especially compared with what I hear others talk about from around the country). 

I buy multi-families in Stockton, the Cash on Cash returns can be higher than what others have listed above.  I rarely have trouble finding tenants and have everything running through property managers.  The deals are fewer now.. but they are there.

Great numbers Matt! I think over the long run your maintenance expense will be a bit higher. Do you have AC units for each unit? I've had to replace several in my rentals in Phoenix and they do not last as long as I hope they would. 

I do like the Stockton/Tracy/Turlock markets. I am currently working on an off market apartment complex in Lincoln Village, I'm crossing my fingers it will work out.

Thanks for sharing the excellent post Matt.  I would also have some questions about a $170/mo number for both vacancy and maintenance on a Stockton duplex.  Is Cap Ex included in that $170/mo maintenance/vacancy number?  It seems like just Cap Ex itself over say a 10 year hold period on a Stockton duplex would be more like say at least $250/mo?  Chances are on a duplex in Stockton over the long term (10 yrs) you may get another problem tenant that may do damage or need to be evicted.  And you may have to do a few more of those  $2k+ a pop paint/carpet/etc.. turnover deals.  But being newer 2002 built + having low cost yard will help.

@Johnson H. Yes both units have HVAC, which haven't required maintenance yet. Of course, they will over the long run. Lincoln Village is a nice area. Good luck!

@Rob Cee you're right - with this property I do expect a rougher tenant profile and it's likely I'll have another eviction or two over the long run, so being conservative with the expense numbers is prudent.

@mattshamus do you have any recommended property mgmt. company out in Stockton?

@mattshamus do you have any recommended property mgmt. company out in Stockton?

@Mai Vo unfortunately I have not had much luck yet with a property manager. I am currently using one for this property but am not pleased with the service. I find that with a smaller property like this (and none of my other properties under management with them) the property manager is just not well incentivized to do more than the bare minimum. 

Matt

How do account for the the $2K for repairs and whatever it cost you in missed rent and legal costs to evict the non-paying tenant?  Is that part of your all in cost?  Or did it use up your first year's allotment?  

I actually liked the numbers until I saw it was a duplex.  While most people like units, I dislike households paying low rents in urban areas of CA. A family or household paying $1800 rents is generally way more secure than one paying $900.  How big are these units?

Where did you get the 4% financing on a rental?

@K. marie in the analysis above the $2k eviction/repairs cost was not accounted for. It happened in a prior year and I think of it as more of a one-time expense as opposed to a recurring expense. That said, you're right that it would be prudent to account for these instances going forward. 

You're right that a lower price point will of course attract a certain profile of tenant, and that's what I'm seeing here. It's important to note that this property is not in the best part of town, and compared to my other properties and my strategy it doesn't fit well with what I do. But it did at the time and I've learned a lot about my investment criteria from owning it. 

The units are each 3BR/1BA and about 840 square feet. 

Financing via a local credit union who I have a great relationship with. 

Originally posted by @Matt Shamus :

@K. marie in the analysis above the $2k eviction/repairs cost was not accounted for. It happened in a prior year and I think of it as more of a one-time expense as opposed to a recurring expense. That said, you're right that it would be prudent to account for these instances going forward. 

You're right that a lower price point will of course attract a certain profile of tenant, and that's what I'm seeing here. It's important to note that this property is not in the best part of town, and compared to my other properties and my strategy it doesn't fit well with what I do. But it did at the time and I've learned a lot about my investment criteria from owning it. 

The units are each 3BR/1BA and about 840 square feet. 

Financing via a local credit union who I have a great relationship with. 

Thanks for the additional info.  A "one time" eviction and repair expense of $2K+ in the first two years of ownership?  That's playing funny with the numbers.  It's either an all-in cost or it's part of your maintenance/capex budget reserves.  Yeah, 3/1s renting for less than $900 in urban CA isn't my thing.  I can handle rural and desert in that rent range, but not urban. 

Originally posted by @Mai Vo :

@mattshamus do you have any recommended property mgmt. company out in Stockton?

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here