The world is not run by bright people who work hard and get a paycheck. Throughout history it has been run by people who OWN things, especially property and land. Don’t we all wish our Great Grandparents had bought some of that empty land down by the ocean?
While short-term fluctuations in value, and cash-flow, are a consideration in every investment, long-term investments in property can build wealth, security and influence for generations of your family.
I firmly believe that California is one of the premier places to invest in property right now and for the future. Growth in value is driven by the health and diversity of the economy, population growth and the supply of housing. In areas such as Los Angeles and Orange County, the housing supply is limited because there is little land left to build on; the economy is now much more vibrant and diverse than it was in the early 1990s when it was defense and aerospace dependant; the population of California is predicted to double again in the next 30 years. All these people need to live somewhere.
However, as I pointed out in an earlier post, the picture right now is complex.
As an investor, first of all you have to decide priorities. Are you looking for cash-flow, return on investment, short-term capital growth, long-term capital growth, ease of ownership and management, low maintenance, location in a desirable area?
I know the facetious answer is “Yes please, I’d like all of those”, but unfortunately that is not reality; and before we even go there, you can forget about 10% “cap rates” in California on residential property, which is a request I have had from European investors. Reality is 5% to 6.5%. There are areas of the country which may tantalize with prospects of higher “cap rates”, but I think you will find them in more economically unstable areas with much higher risks to value and much lower prospects of future capital growth.
Let’s look at a few typical scenarios around my area to illustrate the picture. Such places are available now in California and remember that purchase prices are down 20-50% from the peak which was late 2005/early 2006.
1) Cheap condos in less-desirable areas: Low purchase price, some even below $ 100k. High percentage of renters in the complex, higher turnover of tenant, greater chance of delinquency. Can be a very good investment but really needs to have “hands-on” oversight to protect the investment and ensure high occupancy.
2) Nicer area, better condo complex: 1 bedroom condos in the mid 100s, and 2 bedroom in the $180k-220k range. Good investment in my personal view, but not without risk. One of the problems affecting a few of these complexes is that most lenders will not lend when the owner-occupier ratio falls below 51%, or when the Home Owner association fee delinquency exceeds 15%. If lenders will not lend, it means the universe of buyers is restricted to those with cash. That may sound attractive if you are a cash buyer as prices will be forced down, BUT there is no obvious mechanism to restore the complex to the ratios under which lenders will lend. So the liquidity of your asset is questionable in these complexes. Many of the sellers in these complexes do not realize the problem they have. However, good quality condos in financially stable complexes, are, in my opinion, worthy of attention for investors. Rents are good, maintenance is less than older condos, and the prospects for future capital appreciation are quite good. The purchase price of many of these condos is over 40% lower than 3 years ago.
3) Small to medium-sized single family homes: This is a niche that I think is also worthy of attention. Generally appeals to a stable renter, maybe a small family and has been hit by a similar fall in value. The competition for these properties, however, is stiff. A cash buyer sometimes has an advantage. I believe this niche will present a good chance of capital appreciation when the market recovers. The price levels in this niche are where the Government has intervened to give better borrowing opportunities then previously existed before the price crash, so, come the recovery, I expect to see a lot of activity in this area. One thing to consider is that, although HOA fees are generally much lower than for condos, the insurance and maintenance of the building falls on the owner and some of them have special bonds attached which increase the effective property tax rate.
4) High-end Houses: These houses are seeing a big fall in value and have much upside potential eventually. However, the timescale for recovery in the high-end market is, I suspect, longer than other segments. Also, in California we are still talking quite substantial amounts of cash being invested, and this high-end market is highly illiquid. This end of the market would require the willingness to hang on to the investment for a long time. Renters are also less in evidence when talking about over $ 5,000/month.
These are just a few of the considerations to get you thinking along the right lines. If you are looking to buy investment property, it is important to have a detailed analysis of costs and risks, preferably all laid out in a form where you can compare returns and evaluate. Then set up target parameters before you start to actually search for property.
As in life, things do not always run to plan, but that does not mean you shouldn’t have one.
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