In the long run (5 years or more), the inevitable property appreciation and equity build-up results in wealth and positive cash flow.
The amount of equity needed to generate positive cash flow increases as the expected appreciation increases. If there is little appreciation expected, then investors require greater cash flow. If there is swift appreciation in the market then cash flow becomes less important.
During the last 15 years annual rents for houses in Fresno have been roughly equal to the mortgage rate times the value of the house. Between 2002 & 2005 home prices in Fresno increased dramatically and rents were stagnant. Rents for single family homes started to rise slightly in 2006 but stagnated in 2007 & 2008. During 2009 There was downward pressure on rents which continued through 2011 as vacancies have increased. Annual rents had been 4.5% to 5% of value during the boom years. Now that housing values have declined we are seeing annual rents equal to 8% to 10% of current market value. Example: The annual rent for a $135,000 house is about $12,000 to $13,000 ($1000 to $1100/month) or 9% to 10% of value. (posted 2/15/2013). This situation is not stable since interest rates are in the 3.5% to 5% range for investor owned homes. The cost of ownership for the same house is about $800 per month with nothing down. One of two things (or both ) can be expected to happen: 1. rents will decrease or 2. home values will increase However, this has not happened in 2012. Both home prices and rents increased. Why? Probably because vacancy has declined due to the lack of new construction.
Gross rent & net income are of course different things. My analysis of 20 residential properties shows a net cash flow after all expenses except debt service equal to about 6.4% of value. Here is an analysis of the average house:
|Maintenance & Repair||-500||- 1,825|
|Net cash flow||8,820||$6,855|
|Market value of Property||$137,000||$150,000|
The 2012 overall net cash flow will provide a cash flow of about $175/mo with a loan of $110,000 at 4.5%, 30 year (80% loan to value). Equity of $27,000 would be required. That's an 8% cash flow on equity. Part of the payment will be principle and a loss will be shown for income tax purposes after the non-cash expense of depreciation. This is a big improvement over 2009 when 30% down was required to break even.
Is that a good deal? Works for me. Where else can you get an 8% tax sheltered return? See Bob's get rich scheme.
It is interesting that investors in real estate often expect to put 0% down and receive a positive cash flow. If this were possible then everybody would be buying property and the prices would be driven up and the cash flow down.
These same investors make stock market investments that produce no current cash flow and only a hope of increased value. They would never even think about financing stock purchases especially not 90% of the cost. So why do they have such unrealistic expectations of real estate investments which seem to have less risk?
PAR 4 Properties is owned by
Robert E. Hooke
4025 N. Fresno #104, Fresno CA 93726
California real estate broker's license #00620183
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