Ahh...the joys of owning...

March 28, 2008

Ah...the joys of owning...

Our early-spring perusal of rental properties is always interesting. This year, instead of listing properties and pontificating about market prices, let's simplify things and just look at projected cash flow.

To enhance your experience, we document how a couple of these jewels are owned at one price (from, say, eight or ten or twenty-five years ago) but would cost the current owner something else entirely. Let's look at:

"BEFORE" = the cash flow required by the current owner

"DURING" = cash flow spent by the renter

"AFTER" = cash flow required to buy it at the current Zestimate

Here we go:

1) 4 bedrooms, 2 baths, 2 car garage, 1,698 square feet, built in 1959. (Los Altos) The current owner paid $243,000 in 1984.

BEFORE:Assuming 6% interest-only 100% financing, interest cost is $14,580. Add Zillow's $4,809 in real estate taxes plus 1% maintenance/insurance at $2,430 (aka "overhead") and you can project a total cost of ownership at ~$21,819.

In reality, this owner's interest cost should be zero once you (quite reasonably) assume wage and income growth in Silicon Valley since 1984 enabled anybody who could already swing a quarter-million dollar house in 1984, at the ~8% -9% interest rates common at that time, to pay it off over the course of 24 years.

To address a couple of the other corner cases, the above "cost" might seem ridiculously low. Yet these were exactly the types of financing assumptions (I-O, minimum insurance /maintenance /repair costs) made by hundreds of thousands of "investors" over the last three to five years.

DURING: The renter's cost is very simple: $3,500 per month times 12 = $42,000.

Even curmudgeons like us have to admit this circa 1984 owner is experiencing the joys of owning. Income is nearly twice cost!

AFTER: The $1,411,500 Zestimate for this place implies $84,690 in interest plus $17,644 taxes plus the same $2,430 "overhead" for a $104,763 minimum cash flow.

That's a swing from 0.5x to own up to 2.5x to own. (Charitably calling somebody with an I-O mortgage an "owner.") The minimum cost to buy and own today is 2.5 times the cost to rent. That's some real joy of owning there, boy!

2) 3 /2.5 /2 /2,104 square feet built in 1950. (Saratoga) There was NO prior sale history but $4,779 in taxes. If the step below a "back of the napkin" estimate is a "seat of the pants" guess, the one below that must be a SWAG (aka "Stupid Wild A** Guess"). Our SWAG here is $250K.

BEFORE: The same math as in 1) work out to $22,279.

DURING: $3,250 times 12 = $39,000.

AFTER: The $1,501,000 Zestimate works out to $111,323.

The current owner collects 1.75x his cost but a new buyer pays 2.85x the cost to rent. How joyful is that?

3) 5 /2.2 /2 /1,938 square feet built in 1951. (Los Altos) Again, no sales history but this time a tax bill of $2,030. Based on the lower tax bill, our SWAG here is $100K.

BEFORE: $9,680.

DURING: $3,400 times 12 = $40,800.

AFTER: The Zestimate is $1,582,500, so use $117,000.

Now it's getting a little boring. The same thing over and over. The "old" owner earns over 4x over cost while a "new" owner spends 2.85x over cost. Boring is not joyful, so let's press on.

4) 4 /2 /2 /19,73 /1985.(San Jose) (Wow! Modern construction?!?) Sales history shows $400K in 1999 with a tax bill of $5,824.

BEFORE: $32,254

DURING: $2,700 times 12 = $32,400

AFTER: Zestimate = $795,000, so $60,068.

Even with a pre-bubble 1999 purchase, the "old" owner's is barely breakeven! A "new" owner is immediately paying 1.85 (or 185%) of the cost to rent. Not much joy here in Mudville (err, San Jose).

5) 3 /2 /2.5/ 2,189 square feet built in 1948. (Los Altos) No prior sale history with a tax bill of only $3,275 which we SWAG at $165,000.

BEFORE: $15,605 (probably a lot less)

DURING: $3,500 times 12 = $42,000.

AFTER: Zestimate = $1,675,500, so $123,904.

The current owner is raking in 2,7x (and probably more, big joy!) his cost but a new owner pays nearly 3x the cost to rent.

6) 4 /3 /2 / 2,705 built in 2001 (Cupertino) (2001? Holy cow!) Last purchase was $1,000,000 in 2005 with $12,035 in taxes.

BEFORE: $74,465,

DURING: $3,800 times 12 = $45,600.
AFTER: Zestimate= $1,280,500 which works out to $95,266.

The current owner is burning at least $30K (Yikes!) which is "good" only when compared to a "new" owner losing $40K every year (Double Yikes!!).

One the one hand, this owner "gained" $280K in the value of the house. Unfortunately, over those same seven years they gave back $210K in negative cash flow. Could you think of better ways of using $1M to earn $70K in seven years?

7) 4 /2.5 /2 / 2,280 / 1988 (Sunnyvale). Last purchase 2006 at $975,000 with $8,963 in taxes.

BEFORE: $69,893.

DURING: $4,000 times 12 = $48,000.
AFTER: Zestimate= $1,119,500 which works out to $83,593.

Same deal, different city. The "old" owner loses ~$22K per year but a "new" owner loses $35K+.

We have easily a half-dozen more examples of places we might have considered renting, but you get the idea. No matter where you look, rents do not cover current prices --it's not even close!

Anybody thinking about buying based on recent headlines needs to study the above figures a little more closely.

Conclusion: Do we even need to say it? "You make your money when you buy real estate, not when you sell it."

There is a lot of talk about housing prices bottoming now. Or later this year. Or certainly by 2009. We submit guessing the time by which local prices will bottom is a fool's errand.

We insist the ONLY relevant metric is price. Prices ran up 50 and 60% since early-2004. Only after prices give up most of that mania-induced run-up will it make sense to get back in the water.

Coming soon: Several properties formerly listed for sale are now available for rent, or rent-to-own. Hmmm...