Austin Real Estate Investing Not Always Profitable

by Steve Crossland, REALTOR in Austin TX on October 28, 2011 · 7 comments

Sylvia and I just sold a couple of acreage lots that we purchased in Oak Hill back in Feb 2007. For those who remember, Austin’s real estate market was still running full tilt in early 2007. I bought three lots in a new subdivision, we built a new custom home on one of them and moved in, and held the other two for investment.

The Original Plan – what was suppose to happen 
We bought the lots directly from the developer for around $85K and $90K each. I figured they would be worth $150K or more within the following year or two. The house we built, which we really didn’t need but which I though would be a good investment, cost about $475K to build turnkey, including lot purchase. It appraised for $610K when we closed the loan, which I thought was a bit high, but nevertheless I figured the value would appreciate to over $700K within two 2 years. We’d sell it, take the tax free capital gains, and buy again in Westlake near the high school.

I think of this strategy as “laddering up”, whereby each successive home purchase/build and move-up results in tax free income and an increase in net worth. Others I know have done this with “slow flips”, buying fixers and staying the required 2 years while renovating, then capturing the tax free capital gain and reinvesting into the next home. Over time, this is a powerful formula.

On paper, this all made sense. The home we’d lived in prior and sold to build this one was built in 2003 on another lot we’d owned since 1999, and it had appreciated nicely. Because of our convoluted tax system, there was a sizeable capital gain profit to be taken tax free on the sale of that one. Those proceeds were dumped into the new one to start a new two-year clock ticking. Any home you sell that you’ve owner-occupied for at least 2 of the past 5 years is not subject to capital gains tax upon sale, so in an appreciating Austin real estate market, moving often can actually be a wealth building strategy and a way to earn tax free capital gains.

What Actually Happened
The plan didn’t work out as expected.

The instant equity we had upon completion of the home vanished in Austin’s real estate downturn. We sold the house for slightly more than we paid to build it, but that wasn’t the plan. The lots did not go up in value either. After holding them for 4.5 years at a cost of about $8,400/yr each (interest and property taxes) we sold them for slightly more than we paid.

Everything I predicted will eventiually happen with regard to values, but over a 7-10 year timeframe instead of 2. Basically, as I look back on all of our real estate investing in Austin since the 1994 when we purchased our first rental property, that house and those lots rank up there near the top with real estate investments that lost money instead of making money.

Why I’m Not Upset
If you want to be a real estate investor in Austin, or more specifically, if you want to use real estate as a wealth building vehicle, you have to be on the field playing. That means taking risks in search of rewards. In hindsight, are there real estate investments I wish we would have avoided? Of course. But there are even more that did work out, some exceptionally well. Sometimes you hit a Grand Slam, other times you strike out. Meanwhile the singles and doubles keep things moving along. Over time, especially over decades of time, it all pans out in the end. So I’m not upset or worried about this hiccup at all.

But What About Small Investors Doing Just One Deal
This is what scares me. One investor doing one real estate investment one time that doesn’t work out. The real estate investing landscape all across the U.S. is littered with these investors who got in during the bubble, many using their home equity as down payment, and watched their real estate investments crater. Some hung on and still own those properties. Others went into foreclosure or short sales. Most are permanently wounded psychologically, having gone though difficult financial stretches trying to hang on. They never should have invested in the first place because they were not financially prepared to do so. Most will never buy real estate as an investment again.

Which is good news to the rest of us. Thank goodness the Amateur Decade of real estate investing is over. Renting has come back into favor, which benefits those of us holding long-term rental investments. Loans are no longer being given to unqualified borrowers. People are now more aware and skeptical of “get rich quick” real estate programs and flip shows on TV. Ironically, since I sold my two lots each for more than I paid, a cable TV show on real estate investing would call that a “profit”, albeit a small one. Hopefully people are smarter than that now, and understand that there are “silent” carrying costs that these shows ignore in favor of the sexier gross numbers they show on the recap.

Meanwhile, Austin’s market is coming back. I sold my lots at the dip. Had I kept holding another 3 years, the values would have increased substantially. But sometimes you just cut your losses and move on.

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