05.04.05
How to measure return?
If you’ve been at real estate investing for a while, you will discover there are many ways to measure the your return on your real estate investment.
The first step is to figure out whether a property cashflows or not. Meaning, is there money left-over from the rent when all the expenses have been paid? Often the cashflow calculation omits the variable cost, such as maintenance and vacancy, making the property look better than it actually is. Be aware of this when you look at investments promising a certain cashflow. Another gotcha is that proformas often quote the taxes and insurances that the owner pays, not what YOU will pay. This is particularly deadly in states in California where the property taxes only go up when the property is sold.
Knowing the cashflow of a property is all well and good, but it doesn’t tell you how well you are leveraging your money. For example what’s better? A property that cashflows at $200/mo if you put $25,000 down? Or a property that cashflows at $75/mo if you put down $5000? If you said the latter, you are correct. The second property provides a cash-on-cash return of 18% (75*12/5000), while the first is 10% cash-on-cash. Cash-on-cash is a measure of how quickly the cashflow from the property pays back your investment. The faster you get your money back, the faster you can can use it for another investment.
None of these measures take it account any equity growth in the property. If you buy a property for $100,000 and sell it two years later for $175,000, was it still a good deal if the cashflow was in the negative, say $100 a month? Many investors would say yes, they point out $2400 is a small price to pay for a $75000 gain. But counting on equity for a good return does start crossing the line into speculation and you will get many opinions on where to draw the line. A good measure that looks at both cashflow and equity is the internal rate of return. The real estate journal has a great explanation of what is meant by internal rate of return. This article was the first I had heard of this measure, I had always looked at “total equity return” which is cashflow + equity growth + principal reduction + tax savings. Internal rate of return is a little easier to calculate and should give you a good sense of whether you did well with a particular property.
05.01.05
No Cashflow here
I recently went to Palm Springs for four days. We thought there might be opportunities to buy break even properties in the surrounding communities. In California, the land of negative cash flow, it seemed compelling to check it out. Sweetening the deal was that we got to stay for free in a guest house in a beautifully landscaped estate. Well I didn’t find any cashflow opportunities but it was an interesting visit.
I’ve never been to Palm Springs, but if you are considering it, April is a great time to go. It’s not too hot and all the manicured landscaping is in bloom. Palm Springs is where many have second homes, often in gated communities. The social scene is laid back and filled with dinners at the clubhouse, shopping and popping over to Edna’s to have a glass of wine. With all the lawns and golf courses you forget that you are in a desert. However that will change as all new developments are mandated to have zero or desert landscaping.
We found 2br + den homes in gated communities as cheap as $269,000. Because of the amenities, you can rent these for more than the standard $1200-$1400 you would get for a 3 bd in La Quinta or Indio. However the HOA fees can be stiff, ie $430 a month, and suprise, some of these are on land leases which adds an additional $100 or so a month.
When you enter the desert from the west you drive by fields and fields of windmills. At certain times the wind is intense, especially in the spring. That’s why the most desirable areas to live in are in the south, nestled up against the mountain range. They get the least wind.
In our opinion the best place to buy for the long term if you don’t have tons of money, is La Quinta Cove. Right now there are lot of houses for sales in the hi 200k low 300K range, so perhaps a deal could be negotiated. La Quinta Cove is sheltered from the winds on three sides and not far from other communities. Rents range from $1200-$1400.
The numbers do work better for Desert Hot Springs. A community to the north west of Palm Springs, new homes can be gotten for $240-$300K, rents are about the same as above. However I would approach Desert Hot Springs with caution, the winds sometimes cut it off from the communities to the south and there were at least 7 ads in the local newspaper advertising brand new homes, never lived in, for rent. I would research the Inland Empire first before settling on Desert Hot Springs.
If you are a rehabber there are plenty of opportunities in the area, for example, in south Palm Desert we found a couple of houses in the 400K range that could be rehabbed and could sell for at least 100k more. We found a 800K house discounted 100K. The area is growing in population that has money. The rehab and fix strategy would work here. Or even straight flips. I saw several “we buy houses” signs. Perhaps the numbers would work better if a flipper found you a screaming deal.
One comment I heard from a realtor that I wanted to pass along was that he felt that the local real estate market was tied closely to the Bay Area and Los Angeles. When those area economies went down, Palm Spring real estate sales suffered. Whether, with younger folks moving in, that is still the case is a subject for debate.
In the end, I decided, that with my goals, I wasn’t interested in buying in the area.
