So much of the country hasn’t experienced the 15-40% annual appreciation rates places like San Diego have experienced several times. Regardless of the down times, we’ve learned she always comes back smiling. The market? In the end, she would always love us. She always has. Though at times she could lash out, she always made up for it with lavish gifts of abundant appreciation. That may still be the case in regions like SoCal, but it’s my belief it won’t include the vast majority of residential income property.
There are several reasons allowing investors to conclude this. I wrote about many of those reasons in over at my place, adding a video for fun.
First and foremost, developers paid attention in eighth grade math class. They can make $X building duplexes or fourplexes and the like OR $X+ building condos/townhomes OR $X+++ building single family residences — and all on the same piece of dirt. Go figure, they chose to build where they found the most profit. This has been happening in places like San Diego since the ’80’s.
The only residential income product built since then has been recently. It’s been concentrated on the coast and upper income locations with rents that are incredibly high. These newish projects are not competition, nor do they have any positive affect on the values, rents, or vacancy rates of 35 year old duplexes. Duh.
An example is a new place offering 1 bedroom apartments for twice the rent of competition half a mile away. Twice as much. They also offer their tenants everything but a Friday night date — something I’m sure they’ll correct upon reading this.
The point is that the market? She’s left you. And she ain’t coming back no matter how much you turn on the old charm. When investors have the choice of putting less than 35-50% down just to break even, they’ll do it. The party’s over. Capital flows to the best returns. Duh. So why do folks in places like uh, the west coast for instance, insist things will revert to the status quo they’ve relied upon for so many decades?
They’re spoiled. I speak as one of them, who admittedly came late to this fundamental reality. I’ve been shouting from the mountain top ever since. (around late ’03)
Their true love has never let them down. She’s never made them actually work for the profits from which they’ve benefitted. In San Diego, buy something in ’76, exchange it in ’78 for a substantial profit and more magic property. Recession. She turns her back on you, miffed. Buy again in ’83-84 and exchange all your stuff in ’87 and again in ’89. S & L Crisis — she’s really upset at you this time. But she’ll get over it, she always does.
It takes her longer that time, but she comes around just as you knew she would. Lord she’s gorgeous. You tax defer everything again in 2000, and find yourself feeling pretty special. Then you do it again in ’02 and once more in ’04. In the the five years 2000-2004 you’ve literally made gains requiring two commas, and all in San Diego.
You’re thinking she still loves you.
Then she decides it’s over in ’05. Without warning, (at least that’s your story) she’s been seeing others. Turns out she’s been planning this for quite some time. While you’ve been making all this money, she’s cut you off — and you may not realize it’s permanent. She doesn’t care anymore, yet you insist on sending flowers.
Counting on her loyalty isn’t a bet I’d make, considering your retirement is what’s at stake.
Forget her, and realize what’s she’s done with you. She’s allowed you to keep thinking she was your true love, when in fact she’s allowed your properties to become very unattractive to investors. They’re old, require much maintenance, are many times functionally obsolete, and frankly are becoming the default for those with poor credit, and the inability to live anywhere else.
Sure, you retort, but that last bit describes rental property almost everywhere. True enough. But would you rather have a well employed tenant on their way up, who has chosen to live in your unit and in that neighborhood? Or deal with your tenants, lifetime renters who hate living in your units because they now realize the dream of home ownership is probably not gonna happen, at least not in San Diego. They’ll either join the folks leaving places like SoCal for Arizona, Idaho, Colorado, Texas, and Kansas City, or remain in San Diego until the choice simply isn’t theirs any longer.
She’s not coming back. There are some pretty sexy markets out there doing there best to get your attention. Go where you’re wanted.
Wow, look at her, is she hot, or what?!
Geno Petro says:
Hey Jeff,
That was a great read. I know (knew) her. I kind of hope and don’t hope I see her again. But like you say, “Lord she’s gorgeous…”
April 13, 2008 — 3:49 pm
Steven Leung says:
Jeff –
I remember hearing a lot of what you said about the west coast a few years ago, how people felt they were entitled to double-digit appreciation in one or two years of ownership (in this case on their primary homes). It’d make me want to run straight for the hills after hearing how their uncle, cousin, etc. bought, repainted, then flipped and they wanted to do the same when the data (in this case their finances) didn’t support their business model.
For a while there was some flight from Silicon Valley (several years after the well-publicized dot-com bust). We’ve benefited from some major IPOs, job growth, strict government regulation limiting supply, and a work-a-holic culture that keeps folks here wanting to take on new challenges.
She’s not as gorgeous as she once was, and we while we love her just the same, we took her for granted.
But I’m not sure about her spoiling us, there’s a lot of work by millions of people and registered voters that goes into adding value to the local economy: engineers, teachers, police, even bureaucrats. And we try to take care of her as well as she takes care of us. Some days better than others.
Thanks for the post, Jeff. This type of thought inspiration is why I joined.
April 13, 2008 — 4:46 pm
Jeff Brown says:
Steve — Your point is well made.
Communities strive to create the best environment possible, which results in prosperity.
Having returned recently from Palo Alto, it dawned on me they were no different than San Diego investors. Like SD they’d created a virtual paradise in which to live. That hasn’t changed for either area. Speaking for myself, the only problem living in San Diego is where to go on vacation. 🙂 Palo Alto struck me as an incredible place
My point was aimed though, at investment properties, especially the 1-4 unit property, which comprises most of the market in many regions. They are now priced so high, they’ve become punch lines to a joke their owners are tired of hearing.
It’s bad enough in SD, but Palo Alto? Suffice to say, an investor insisting on keeping their capital they will soon learn objective investors balk at putting 40-60% down merely to avoid negative cash flow.
Their true love has left them too. Only the most stubborn are remaining in SD at this point. When they find their cash flow or capital growth can be improved 2-5 fold, they begin to pay attention.
April 13, 2008 — 5:46 pm
Jeff Brown says:
Geno — Thanks.
Yeah, she’s one of those who definitely generate mixed feelings. Been there, done that. If she ever attempts a comeback in SoCal, it will not end well.
April 13, 2008 — 6:04 pm
Steven Leung says:
Jeff –
Good call about Palo Alto, it sounds like there’s a lot of the same that you’ve been experiencing. I wrote a Silicon Valley year-in-review and the median for single-family homes there was up 15.6% y-o-y. That’s the 5th year in a row of growth (though the ’05-’06 increase was “only” 3.5%).
One joke I tell is that the easiest way to get cash-flow positive on a rental property is to found a Silicon Valley startup that specializes in time machines and buy 10 years ago.
I’m not an expert on multi-unit investment properties, though, and I wonder if you did any analysis on East Palo Alto (different city, different county, but right across the 101)?
Definitely not the place for a vacation, at least a relaxing one! And the local government is placing some restrictions on raising rents because of the amazing increases we’ve seen. But local and “affordable”. Based on what you wrote, it doesn’t sound like your investment profile, but I thought I’d ask.
Cheers,
Steve
April 13, 2008 — 7:00 pm
chris says:
1-4 families are priced out of sight, in my area in CT they all need to come down almost 50% to start to make sense again. The sad part is the sellers are wondering why they are all just sitting on the market. Not a single one in my city has gone under deposit in the last 6 months. I still cannot understand why people thought it was a good idea to buy these things and have tons of negative cash flow. However if you can steal them, they do make great investments.
April 13, 2008 — 7:03 pm
Jeff Brown says:
Steve — As soon as you said, “…And the local government is placing some restrictions on raising rents” I heard rent control and put a giant electric fence around that area. They’re dead to me. 🙂
When properties are made affordable for one person at the expense of another through gov’t theft, I opt out.
April 13, 2008 — 7:10 pm
Jeff Brown says:
Chris — A San Diego investor I know just closed a sale on his fourplex — for — here it comes — a MILLION bucks.
And SD income property owners think future investors will find their units attractive? Some would say a blood test is in order. 🙂
Even if you steal them Chris, your profit is predicated on the greater fool theory, isn’t it?
April 13, 2008 — 7:13 pm
Thomas Johnson says:
Allow me to offer an alternative to that once upon a time hottie: Miss USA (formerly Miss Texas).
http://preview.tinyurl.com/6xx4pt
Call now, ERAHouston is waiting by the phone for a date!
April 14, 2008 — 7:14 am
Chris says:
No, I won’t buy anything unless it cash flows. For $1m if it cash flows with say 20%-30% down, great. I want a good ROI, the total cost isn’t nearly as important.
My uncle just made an offer on a 2 family in an area that I think sucks. Its worth $180k, they are asking $199k and the bank is going to take it in 3 weeks. The owe $60k on it, idiots. Total cash flow is $1300, not counting any vacancy. So if you can get it for $100k-$125k, and put $20k into it, thats not such a bad deal. When the market comes back it will probably be worth $200k but never much more. He offered $125k, they said no, came back with $105k, they said no.
As P.T. Barnum said their is a sucker born every minute. So I have no doubt that someone will be able to get $200k for that place in 3-5 years.
I want cash flow, IE a good ROI. I firmly beleive your money is made when you buy a property. Any appreciation is simply icing on the cake. By purchasing low in a down market, you can hopefully improve your chances for some appreciation, but if not oh well.
The fundamentals of 2-4 unit properties still suck, they need to come down. Thats why as soon as I can afford to I want to buy the larger stuff. As soon as you get over 10-15 units they start to look better.
April 15, 2008 — 8:47 pm