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.
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.
|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.