Austin Real Estate Investing – Then and Now

by Steve Crossland, REALTOR in Austin TX on May 2, 2009 · 12 comments

Since the end of WWII, rent prices in the U.S. have run parallel to relative sales prices consistently over time. By this I mean that a $60K home would normally rent for about $600 per month, or 1% of its sales value. The chart below illustrates the gap in sale to rent value ratios that has developed over the past 10 years in Austin in a certain class of home. I limited the stats to what I believe is the “meat and potatoes” or “bread and butter” rental stock. Those are homes between 1400-2200 square feet in size, minimum 3 bedroom, 2 bath, 2 car garage and a maximum 4 bedroom, 3 bath, 3 car garage. 

Of course there are rental properties outside these parameters, but for an investor following the approach we follow – to stick with good, basic homes that will always attract good average renters –  these are the homes that accomplish that. So the chart below shows both sold and rented homes in Austin that fall into the above profile of basic rental stock. 

 

Austin Sales to Rent value ratio from 1999 to March 2009


What we see above is that sales values essentially ran away from rent values in the early 2000s in Austin. In 1999 and 2000, the ratios for typical rental stock were holding to historic ratios. 

Our sales market would have taken a larger dip after 2001 were it not for the investors fleeing the dot.com tech stock bust and turning to real estate. Also, we had home owners unable to sell and turning to leasing instead, which created excess rental inventory and drove down rent values. 

The big question is, will these lines ever converge again, and if so, will it be because rent values increase or sales values lag until rents catch up again? Or a combination. Or, alternatively, is the old rule gone forever and rent will continue forward in our lifetimes at a ratio of about 0.75% of sales value instead of the historic 1%. How does this affect the viability of real estate investing in Austin long term?

In 1999, I sold a typical rental home that Sylvia and I owned in Cherry Creek in South Austin, right off of Westgate Blvd. It was a 1400 square foot, brick 3/2/2 built in the 1970s. Our tenant was paying $950 per month and we sold the home for $92,500. The property tax rate then was 1.90% and the insurance was about .5% of the market value of the home.

Today that house would sell for $150K and would rent for $1150 per month. The current tax rate in Austin is 2.2% of market value and insurance is still about 0.5% of market value.

Let’s see how this looks on a comparison chart.

 


1999 2009
Home Value $92,500 $150,000
Rent Value $950 $1,150
Sale/Rent Ratio 1.03% 0.77%
     
PITI (30 yr loan) $750 $1,096
Gross Cash Flow $200 $54

 

It’s not noted above, but I used a 7.5% interest rate for the 1999 PITI and 6.5% interest rate for the 2009 PITI.

A proper and full analysis would include expected maintenance, repair, vacancy and management costs. I’m trying to keep it simple so we’re just looking at the gross numbers before other factors.

So the investor today is operating with about $150/mo less gross monthly operating income, in our example, with which to cover repairs, vacancy and other expense. Also, back in 1999 my maintenance guy cost $25/hr and my plumber charged $300 to replace a gas water heater. Today a good maintenance person is $50+ per hour and a new water heater will cost $700 to replace. Everything else related to home repair and maintenance is more expensive also.

Today’s investor definately has less room for error when picking the right rental property. Is Austin real estate therefore still a good investment? I think so.

It’s been two years since we purchased our last personal investment home. In March 2007 Sylvia and I paid $168K (won against multiple offers) for a 1600 square foot brick home in Oak Hill, built in the 1970s. It’s rented for $1295/mo. Today it’s worth $195K, so our $35K investment (20% downpayment plus closing costs) is doing nicely, especially compared to the beating it would have taken over the same time period in the stock market had I invested there instead.

Yes, by the time you properly factor the incedentals, an investor in Austin today with 20% down payment must be willing to accept $300 to $500 negative monthly cash flow on a typical investment grade home, and some people just can’t buy into that (though they gladly blow money no car payments and lifestyle bling), or they can’t afford it.

But let’s say that I have indeed been negative $6,000 per year for the past two year on my Oak Hill home (which I haven’t, but let’s say I have). I’m down $12K out of pocket, but I’m up $15K on my net worth spreadsheet ($27K appreciation minus $12K negative cash flow). Granted, that doesn’t factor in selling costs but it also ignores tax advantages.

Had I invested the $35K into a mutual fund, and then fed the mutual fund $500 per month additional investment, where would my investment be today? It would be severley underwater. Deeply underwater.

So I have a hard time thinking that real estate investing has been a mistake for Sylvia and I and the many investors we’ve help these past years, even if the ratios and operating costs are tougher to swallow today than a decade ago.

{ 12 comments… read them below or add one }

1 M1EK May 2, 2009 at 2:20 pm

I continue to fear that leaving multi-family out of this equation makes it increasingly less relevant as things get more expensive (the cost gap between an SF unit and an MF unit, i.e. condo, has been growing as land values increase). In other words, you’re likely looking at a sales sample biased towards the most expensive sales, while leaving out a large chunk of expensive rentals (more likely to be in multi-family buildings).

2 Steve Crossland May 2, 2009 at 3:54 pm

Hi m1ek,

I’m not following your point. The sales/rent sample population of homes are apples/apples. What is it you think I should do differently?

I restricted it as I did so that the stats would reflect typical rental/investement homes.

Steve

3 Dena Davis May 3, 2009 at 1:06 pm

I agree with your analysis. I think that we will definitely see a little slide back in values of the multi family properties for this very reason. We have already seen a slide back.

The tax situation here is absolutely oppressive. I think investors just need to think in terms of larger downpayments– that will take care of the negative cash flow. The other thing investors need to keep in mind is that they dont need the pocket change these properties spin off. Its equity appreciation that is so nice. They get paid when they dispose of the asset. ( assuming the bought it right and in the path of appreciation)

4 anonymous May 3, 2009 at 10:31 pm

Steve,
Maybe I am wrong here, but this looks like pretty good evidence of a real estate bubble. A bubble that should have popped when tech crashed, but instead managed to stay around until it was inflated by easy money financing (via historic low interest rates, easier qualification).

Either a bubble, or a new requirement of decent (20% or more) down payments to put perspective buyers in the equivalent house that they would usually rent. Or the unsustainable alternative (for Texas at least): keep building out further.

I know you don’t think prices are going to correct much if at all, but statically, its more likely that the market will revert to its historical trend, and thus prices drop or appreciation stagnates until rents catch up. Either that or in bizzaro land, rents jump to match the underlying cost of real estate.

-Anon

5 Steve Crossland May 4, 2009 at 8:08 pm

> this looks like pretty good evidence of a real estate bubble.

Hi Anon,

An increase in median sale value from about $122K to $165K over a 10 year period is not a bubble. That about a 3% increase per year from 1999 to 2009, for this particular subset of properties.

Meanwhile, the median monthly rent values of the same type of properties fell about $50 over a 10 year period. I think the rent values are abnormally depressed due to oversupply of rental homes in the Austin market.

Steve

6 M1EK May 5, 2009 at 9:14 am

#1, I don’t think the SF market is what people view as important when it comes to rentals (from the renters’ perspective); #2, it’s leaving out a large enough chunk of data (lots more MF units available for rent); #3, it’s becoming biased towards the suburbs.

7 ed May 6, 2009 at 8:28 am

Anon,

Also, there WAS a real estate bubble going on in many states except Texas. So Texas avoided the bubble. It has appreciated over the past few years while California, Florida, Arizona, Nevada were crashing.

I am hoping it will continue to appreciate at a measured 5% to 6% over the next 10 years, but I may be optimistic.

Dena, Steve,

The principle of rental real estate is to put enough down or to find the right deal break even on your rental property investments vs wait on appreciation. It is difficult to do so you can hope in year 3 to 5, it will begin to cash flow as rental rates go up so you can continue to invest. I am just not sure how I can do it after you have 10 properties…

8 Steve Crossland May 13, 2009 at 6:58 am

> I am hoping it will continue to appreciate at a measured 5% to 6% over the next 10 years, but I may be optimistic.

Real estate typically appreciates at 1.5 to 2% above inflation. 5 or 6 percent would be optimistic in the nearterm, but when inflation kicks in later, who knows.

> The principle of rental real estate is to put enough down or to find the right deal break even on your rental property investments vs wait on appreciation.

Not all of us worry about cash flow. I’m not faulting those who do, but it’s really an artificial way of thinking about long term investing. Most investors who chase “better cash flow” actually do worse in the long run than those of us who focus on quality properties in good areas.

I have an old blog articles about this:
http://crosslandteam.com/blog/2008/07/26/dear-out-of-state-investors-we-told-you-so/

and

http://crosslandteam.com/blog/2007/01/10/why-i-just-passed-on-a-positive-cash-flow-investment-property-in-austin/

and

http://crosslandteam.com/blog/2006/07/19/real-estate-speculation-vs-investing-does-cash-flow-matter/

Steve

Steve

Steve

9 ed May 13, 2009 at 7:53 am

Steve,

Where were you in 2005 with this sage advice? ;)

Although I did put 20% down, in established homes, and plan to hold them for the long term, I am one of those California’s that sold rentals and needed my 1031 $$$ to land in a more stable market. What are your thoughts on Georgetown? Is that community in with Kyle and Hutto? Those homes seem to have appreciated nicely over the last few years, but may not to the extent of Austin. Certainly better than California!

10 anonymous May 15, 2009 at 9:38 pm

Ed,
I wish I would have seen your reply sooner. I am afraid you are mistaken. Bubbles must be viewed locally. You are nuts if you expect 5 to 6% per year appreciation in Texas – 1 to 3% per year is typical, and 0% was not uncommon from the 70s through the 90s. If anything, you should expect negative appreciation as the rent to buy multiplier changes back to the past trend.

I called what Steve is describing a bubble, since it was a change from the past norm. The change maybe small in Texas (relative to the nation), but it represents an increase in prices of +25%. Maybe not the +100 to 200% that Cali and Florida had, but still out of the norm. I realize now that I wasn’t clear why I called it a bubble, and Steve thought I meant only in terms of appreciation. It is a bubble in terms of comparable alternatives. Buying a comparable house is over priced by 25% compared with renting the same house in the sample set Steve used as his case study.

11 ed May 18, 2009 at 1:40 am

Anon,

We’ll see buddy. I will keep track of my real estate and you just keep renting and keep making someone else’s mortgage payments.

5% may be optimistic, but did better than that 3 years in a row in Georgetwon while everyone else’s stock and real estate portfolio’s were crashing. Even if I make 3% a year with my 20% down payment, I will earn 15% of my money with signifigant tax advantages.

If USA keep borrowing money and Austin area keeps high ranking school systems, inflation / my appreciation will be fine.

Coulda, woulda, shoulda bought them closer to downtown, but I was more familiar with Georgetown school system and freeway was coming out there so I went for it.

12 jim r. June 1, 2009 at 9:22 pm

It’s sad that you don’t know what’s about to hit you. Austin is swamped in foreclosures. It will get worse.

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