June 4, 2007
Aha!
(c) View From Silicon Valley, 2007. All rights reserved.
We survey the local rental market on a regular basis. The
"good" ones we keep in mind as future options (or leverage vs. our current situation) but the dramatically "bad"
ones we tend to highlight. We found a particularly "bad" one recently and thought you might enjoy.
The Craigslist ad reads asks $4300 /month for a 3 bedroom, 2 bath
with 1,600 square feet. Reading further down the ad finds a 2-car garage, making it a classic 3 /2 /2.
The rent of $4,300 is far, far removed from any connection
with our reality, not to mention what the market will bear for a 3/2/2 with only 1,600 square feet. If you were
willing, and able, to pay $4,300, you could do a LOT better than 1,600 square feet and 56 years old.
No address was given but something about the picture looked familiar...
The relevant parts of this missive
were:
May 16, 2005: Another
house in our neighborhood sold this week and, what do you know, it's already up for rent. (Technically, it's not actually
sold yet but the buyer has already listed it for rent.*) I don't know the exact sale price, yet,
but it figures to be up to $1.05M, or higher. (Depending on how aggressive the bidding was.) Is ANYbody buying
a house around here expecting to actually occupy it?
June 4, 2007: Thanks to Zillow,
we now know the owner paid $1.25M against the $1.05M list price. Aha!, again.
May 16, 2005: The
prospective buyer is asking $3,400 per month for a 45-year-old (at least) house ...
June 4, 2007: We now
see the house is 56 years old, not "just" 45. (Little Aha!)
May 16, 2005: with less than
1,500 square feet.
June 4, 2007: The Craigslist
ad now claims 1,600 square feet. Since no work was done on the house, did it just magically grow? (Zillow gets
the tie-breaker vote and says 1,523 square feet.)
May 16, 2005: A comparable
house down the block (same age, same size) sat empty on the market for about five months at $3,000. We assume the tenants
who moved in a couple months ago paid less than the $3,000 asking price rent (for that other house).
June
4, 2007: After sitting empty for
several months in 2005 trying to find someone to pay $3,400, the owner thinks the 2007 market will support $4,300?
We keep proving we know nothing about local real estate valuations, so we have to admit we don't know for sure...
May 16, 2005: Even
at 4% for a one-year interest-only ARM, the buyer needs $42,000 cash. (If he's actually making an effort to pay off
the principal, add ~$11,000. I'll spare us both the rant about 100% financing and I/O mortgages.) Property taxes should be
~$12,000. Gardener service maybe only runs $2,000 since it's such a small lot.
June 4, 2007: Assuming the 4%
ARM has not reset, annual interest is now $50,000. Add ~$13,000 if he pays down principal and property taxes are
actually ~$15,000. The "good" news is we over-estimated law maintenance which is probably only ~$1,600.
May 16, 2005: That's
$56,000 annual cash out-of-pocket to own the place vs. $36,000, or less, to rent it. If the owner has
enough other income, maybe he rationalizes it's nearly break-even on his balance sheet after accounting
for (~2%?) depreciation (assuming he can still dodge the AMT).
June 4, 2007: Now we
know the annual nut is $76,500. With $36,000 cash flow, that's a -$40,500 cash flow, per year. Since
we know there has been some vacancy, the owner is probably down ~$90,000 negative cash flow over his two
years of ownership, assuming he had zero unscheduled maintenance costs.
If the ARM has reset, then
today's 6.00% interest rates and 100% financing, the carry on this house goes from $76,500 to $101,500~!! (aha!!)
If he put 20% down,
the cost is the original ~$56,000 plus the opportunity cost of $12,500 (5% interest on $250,000) = $68,500.
Even if he gets $4,300
/month, it STILL leaves him at least -$25,000 negative cash flow-- annually.
May 16, 2005: As
the property "inevitably" appreciates 20%, he gains $220,000 by May, 2006. Paying 5% real estate commission
($66,000) he probably expects to net out to ~$95,480 after taxes. (Or $86,240 since we conceded the earlier point
about having additional income, putting him a higher tax bracket.)
June 4, 2007: This
one almost turned out to be true! Zillow's Zestimate today is $1,600,863. The buyer gained $175,000
per year-- at least on paper.
The potential "problem" is
who will actually pay $1,051 per square foot for this 56-year-old house? When much bigger, newer and nicer houses
a couple blocks away sold for sub-$750 per square foot. (A 2,450-square footer at $1.75M leaps to mind...)
We may be missing a potential
"out." The owner may have no intention of renting and instead plans to tear it down. We have seen some
nearby cases where the flipper business model is no longer buy, hold and flip. Instead, they buy, tear down
and re-build a completely new 2,500 or 3,000-plus square foot house, expecting to sell for $2.5M or $3.0M or more. Aha!,
indeed.
As we said earlier, we keep
proving we know nothing about local real estate valuations, so we have to admit we don't know for sure if this would work.
Could we try it with
your money?
