All Forum Posts by: Dan H.

 5th amendment comes into play.  5th amendment also has limits by interpretation of the courts.   Eviction moratorium in effect has LL providing housing in some cases without reasonable expectation of compensation (collection of rent).  In my jurisdiction, the eviction moratorium was the most extreme in the country.   The tenant could break all items in the lease and not pay the rent and they still could not be evicted.   

If the lender has foreclosed and previous owner has vacated/evicted, the lender (now owner) can allow viewing the inside.

 >Some wires got crossed somewhere.

possibly.  In the original post you indicated -$328 cash flow under Austin.  Was this not correct?  Was it a subset of the cash flow?   Maybe there was a typo.  It is the number I used.

In San Diego it is common to see projected rent to selling price ratios of ~0.5%. However, these are not typically what is being purchased by investors or if they are it is because they plan on doing a rehab and significantly raising the rent (a value add). The purchases that have those ratios without the value add and a projected rent increase are virtually all OO purchases. I suspect this is the case in virtually all lower cash flow markets. I have never purchased in my market without at least a projected 0.7% stabilized monthly rent ratio, including the cost of value add in the property cost. Since the rates increase, my underwriting shows 0.7% ratio is cash flow negative at high LTV in my market (while being far superior to the rent ratios that would occur on OO purchases).

I question if your large negative cash flow is mostly derived using stats that include OO purchases. I know if this was done on my San Diego market, it would depict a far worse cash flow than the already bad cash flow that investors are obtaining. I find it unlikely that Austin investors are regularly purchasing investment properties that project negative $1,167/month cash flow (even though my last purchase my underwriting showed a little worse than this per unit (4 units), but it had value add and positive cash flow was achieved in less than 3 years).

Do you believe Austin RE investors are buying at a projected negative $1,167/month?  I think it is unlikely.

I will also point out that if I purchased in my market a property that was negative $1,167, my worse monthly appreciation property is $2700/month.  $2700 - $1167 =$1,533.00 monthly return not including equity paydown and that is my worse monthly appreciating property.  My best is up ~$1m in 3.5 years.  $1m/40 is $25k/month (by the way it is the same property that had the horrendous cash flow at purchase that I mentioned earlier in this post).   Tough to make $25k/month in cash flow with less than 5 units.

by the way my underwriting does not show those cheap markets to have cash flow anywhere near the projections of those investing there.   In general the investors grossly under estimate maintenance/cap ex, do not depict anything for PM and sometimes grossly under represent vacancy/uncollected rent.  I saw a post recently that showed $86/month maintenance/cap ex and a vacancy rate of one quarter the city’s vacancy rate.   The $86 was 10% of rent and is at least a factor of 3 low for sustaining maintenance/cap ex on that unit.   I asked where he got the number and got an initial reply that he had calculated it via cost and lifetime.  It was clear he used 10%.  I called him on it and did not get a response. I asked how he justified using vacancy of 25% of the city’s vacancy rate and got a reply that he was in the suburbs with lower vacancy.  I believe he could have lower vacancy, but 75% lower seems unlikely.  Certainly it seems to be very aggressive underwriting.  I pointed out he had no entry for uncollected rent so his 5% vacancy was covering both.  This is the quality of the underwriting I see regularly in low rent markets.  This under writing is unlikely to be sustainable over any reasonable length hold.

There are challenges in RE everywhere and I believe those in low cost markets should start there (but in the upper half of the price range of that market).   I do not believe these markets are likely to produce the returns that OOS investors seek.

Good luck

 Was the fishing not good or the fishermen not good?   Fishing can be bad for example after storms or heat spells, but poor fishermen always blame the fishing.   What they really mean is the fishing for them was not good.  

Interpretation: I cannot catch any fish so it is the host’s fault.

Reality: I have no clue how to catch fish in this area and that is the host’s fault.

 >Curious what other early signs you’re seeing in San Diego?

according to recently released data by the California rental Housing Association the rents in the city of San Diego rose 9.3% over the last year.  According to rent cafe tha average apartment rent in San Diego is $2975.   So near $300 increase in rent on average.

I suspect non commercial residential is doing fine even if they purchased with some negative cash flow.   The rents continue to increase and most owners have long term fixed financing.

The commercial residential with their shorter term loans may be having issues (everywhere, not primarily San Diego).   I am an LP on a syndication offering of a local value add commercial apartment building.  It is drastically under performing the underwriting; bad enough that I suspect to suffer a loss (it will be my 1st RE related loss).  One of the two primary operators got a divorce and exited as a primary.  I suspect that also may be impacting the performance. 

Last week we placed an offer on a down to studs rehab. We offered $92.5k over the initial asking price with virtually no contingencies (we had HOA contingencies only). I was told at least 4 offers beat our price. I realize there are operators who are content with returns far less than we expect, but our projected return was only $20k to $30k with a reduced cost of money (-50% of what most would be paying). San Diego is definitely a healthy (over heated) market for smaller flips/rehabs.

Good luck

I do not know if you switched numbers from your OP or if your calculation on time span to positive cash flow is off.

You show a negative $328/month on $2200 rent.

Without compounding (with compounding it would be better and take less time to achieve positive cash flow) using your rent growth percentage

1.05 ** years * $2200 - $2200 is the rent

at 5 years

1.05 ** 5 * $2200 - $2200 = $607.82 which is likely enough greater $328 to compensate for expenses other than P&i having risen (basically inflation on the non fixed costs).

>Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.

There are many ways to manage risk.   I believe high diversification reduces risk.  I think only a very conservative investor would have more than a year of safe, liquid reserves (money market, etc).   So your reserve scenario does not match most investor’s approach.  I do agree that the reserves should not all be in one asset class; that is too risky.   But an investor has a year or so liquid and substantial other investment in other classes besides RE, they have a more robust plan than someone relying solely on cash flow.

>By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.

what ends up typically occurring is money is extracted before is gets to a 50% LTV to leverage the capital elsewhere reverting the cash flow. I virtually always have used 30 year fixed loans once stabilized for their safety but I have yet to hold a loan 10 years. With the rate increases that started q2 2022, there is a chance that I will finally hold one of these loans over 10 years.

My worse appreciating property has appreciated $2700/month over its hold.  It never had negative cash flow but even if it did, it could not impact the return significantly.   I purchased for $47k out of pocket including closing costs.  My best appreciating properties have appreciated over $10k/month over their hold.   One of these did have initial negative cash flow at purchase (quite large negative cash flow), but in less than 3 years it had positive cash flow.  The negative cash flow was always inconsequential compared to the value increase.

I do believe the low cost markets are appropriate for local investors.   Long distance investors should seek higher quality assets.

Good luck

I do not know if you switched numbers from your OP or if your calculation on time span to positive cash flow is off.

You show a negative $328/month on $2200 rent.

Without compounding (with compounding it would be better and take less time to achieve positive cash flow) using your rent growth percentage

1.05 ** years * $2200 - $2200 is the rent

at 5 years

1.05 ** 5 * $2200 - $2200 = $607.82 which is likely enough greater $328 to compensate for expenses other than P&i having risen (basically inflation on the non fixed costs).

>Since this is your reserve fund, you definitely have to keep it invested in something safe which will probably barely beat inflation. Let's be generous and say you make 5% on it. So, dealing only with the first year of doing this, you make $16,955 from the house and $7,250 from your reserves, or a total gain of $24,205 on a total investment of $225,000 or 10.8% return. Again, that's making several generous assumptions, and the return continues dropping year over year, which leads to the second problem.

There are many ways to manage risk.   I believe high diversification reduces risk.  I think only a very conservative investor would have more than a year of safe, liquid reserves (money market, etc).   So your reserve scenario does not match most investor’s approach.  I do agree that the reserves should not all be in one asset class; that is too risky.   But an investor has a year or so liquid and substantial other investment in other classes besides RE, they have a more robust plan than someone relying solely on cash flow.

>By the time your cashflow is inching closer to $0, your return on equity is bad, like below 10%.

what ends up typically occurring is money is extracted before is gets to a 50% LTV to leverage the capital elsewhere reverting the cash flow. I virtually always have used 30 year fixed loans once stabilized for their safety but I have yet to hold a loan 10 years. With the rate increases that started q2 2022, there is a chance that I will finally hold one of these loans over 10 years.

My worse appreciating property has appreciated $2700/month over its hold.  It never had negative cash flow but even if it did, it could not impact the return significantly.   I purchased for $47k out of pocket including closing costs.  My best appreciating properties have appreciated over $10k/month over their hold.   One of these did have initial negative cash flow at purchase (quite large negative cash flow), but in less than 3 years it had positive cash flow.  The negative cash flow was always inconsequential compared to the value increase.

I do believe the low cost markets are appropriate for local investors.   Long distance investors should seek higher quality assets.

Good luck

I think anyone that has had STRs for a while have got what seems like crazy complaints.   It happens.   I think crazy complaints need less addressing than less crazy complaints.

I have had complaints for 

Blackout curtains letting in too much light

Guest getting a ticket for parking hanging over the sidewalk

A room with a bunk bed even though it is both in the description and photos

Seating only holding 5 when stated unit max occupancy is 5.

Airplane noise where listing explicitly states unit has airplane noise.

Too much seaweed (our beaches are cleaned often but just before the next cleaning there can be significant seaweed).

Tight parking when listing provides exact measurements of the garage.

I suspect I have got more nit complains or complaints on things that were in the listing than legit complaints.   I also believe the nit complaints have gotten more regular.   I used to get few nit complaints.  I would say I get one every 10 or so reviews now.

Do not worry about it too much.  I would respond to the guest comment basically stating that there was an extreme weather condition that affected the quality of the river.  do not get defensive or disparage the guest. Anyone who reads that review will recognize that the guest comment was not well thought out (bordering on inconsiderate).

Good luck.  

Case Shiller used to publish a list with total residential return for this century.  The top of the list was all high appreciation markets.   The bottom of the list was comprised of high initial cash flow properties.   What the list showed was a strong correlation between appreciation and cash flow over a long hold.   The list showed a poor correlation between long term cash flow and initial cash flow.

I invite you to run your numbers at 80% LTV using that extra down payment to deal with any initial negative cash flow. Use the appreciation and rent growth for this century on each city. Basically the case shiller data without the effort of determining local property tax, maintenance, PM rates, etc..

In have been investing in my San Diego market for many years. I have purchased with poor timing and great timing.  My worse appreciating property has appreciated $2700/month over its hold ($47k down and closing).  My best appreciating properties have appreciated over $10k/month over their hold.  I suspect that virtually all residential RE in my market will have numbers between my best and worse case.

Knowing the San Diego appreciation rate (almost 6%/year for this century per neighborhoodscout) how do you think the rent growth has been?

With time the market with the higher rent growth will always have higher cash flow than the higher initial cash flow market that has lower rent growth.  It is basic math,

So the high appreciation market has historically produced both better appreciation numbers and better long term cash flow than the low value markets.  This is easy to verify and I believe most experienced investors ecognize this. I recognize past history is not necessarily an indicator of future performance but the metrics on my San Diego market still look promising.

My view is the low cost markets are best served by local RE investors who know the nuances of the area.

Best wishes

Thanks for the callout.  I had seen the OP’s post but thought @Rick Albert response was very good.   

I agree with everything Rick Albert stated, and upvoted his response, but believe he left out some of the downside of adding an ADU. For example, if your primary is over 15 years old it now is a rent controlled unit (even though I strongly believe this was not the intent of senator Weinkowski with AB1482). It seems like Albert got good financing, but in general ADU financing has worse terms than loans associated with a property purchase. Albert did cover well the effort (that I claim is comparable to a brrrr with far lower return) and timeline (except sometimes the timeline exceeds 9 months, but it probably should not if the jurisdiction does its part and you have good contractors).

NAR provided Nov 2021 data for many large cities of average sale of properties with an ADU versus without an ADU. My market is one of the worse for ADUs adding values as the NAR stats showed homes with ADUs sold for only $13k more than homes without ADUS. I checked to see if NAR released the data for Santa Clarita/palmdale, but it did not. Los Angeles ADU values are significantly higher than San Diego per the NAR data.

Here is a list of why adding a single ADU in single family zoned areas in my CA market (San Diego) is typically a poor RE investment:
1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

I agree if you can find a property with an existing ADU you will likely get more for your money, at significantly less effort and risk, with better financing terms, and not as long a time before obtaining revenue from ADU. You want to be sure that the ADU is a quality rental (the stuff @Rick Albert indicated and bonus if separately metered or submetered and has its own parking).

Good luck

Most new investors do not have the means to support a large negative cash flow property for an extended period of time.  In addition, most new investors significantly under estimate expenses.

However, once you have sufficient reserves to be unconcerned about the cash flow you should evaluate a property’s investment quality based on total return.

My last purchase had total revenue $3200/month less than PITI. My under writing was showing -$5000/month when allocating for all sustained expenses & vacancy. Not sure how many people have purchase a non commercial property that protected a worse cash flow outlook. Today its value is nearly $1m higher than purchase and value add costs. The market rent is $8k more than PITI. From horrendous cash fliw to modest cash flow, but the big return is in its current valuation. I could never make $1m cash flow on a non commercial residential in 3.5 years. It is not possible.

Because cash flow is taxed in the year earned, it is my least desired source of return. Note if I extract from the $1m of value ($750k at 75% LTV), that money is tax deferred. Via 1031 I can tax defer it to another property. When I die (Everyone dies) the property (or the 1031 exchanged property) gets a stepped up basis and no one ever pays a tax on the gain.

So the answer to the question of how important is cash flow depends significantly on your current finances and where you are in your RE investing journey.

Good luck