I’ve just updated the Investing in Austin page on my website. I wrote it about a year ago and realized it was sorely in need of an update. It now has fresh numbers and charts that more closely match the actual numbers that a lot of our investor buyers are contemplating with the types of Austin investment properties we recommend. I’m posting the cash flow portion of the updated investment page below.
(This is for illustrative purposes only, not a prediction of what you can achieve)
Let’s assume you buy a $225,000 home with a 20% down payment on a 30 year loan at 7%. Let’s say that home will rent for $1,500 per month, or an annual rental income of $18,000 which is 8.0% of your purchase price. Note the other variables in the chart below. Does it make sense for you to invest in real estate in Austin based on these numbers? Let’s look at the chart below.
|Loan Assumptions||Expense Assumptions||Income Assumptions|
|Purchase Price||$225,000||Property Tax Rate||2.75%||Rent||$1500|
|Downpayment||20%||Hazard Insurance||0.5%||Occupancy Rate||90%|
|Interest Rate||7%||Management Fee||8%||Annual Rent Inflation||3%|
|Loan Term||30 Years||PMI||0%||Annual Property Appreciation||8%|
|Loan Points||1%||HOA Fee||$30|
|Closing Costs||3%||Annual Maintenance||$1,356|
Let’s review the above info …
Loan Assumptions – this column should be self explanatory.
Expense Assumptions – Property taxes are high in Texas. They will range from around $2.35 up to $3.25 per $100 of fair market valuation of your property. We’ve used a mid-range of 2.75%, which is the current rate in most of the city of Austin. We’ve added a Management Fee, HOA Fee, and an estimated annual repair expense fee to our assumption. You may not have a property manager or an HOA Fee, and your repairs may not be as high as those in our example, but we want to provide you a scenario that is more stark than rosy.
Income Assumptions – We’ve assumed a monthly rent of $1500. Your actual rent could of course be higher or lower. We’ve used a pessimistic vacancy rate of 90% which would assume that over 1 month a year of rental income will be lost to vacancy and leasing fees. We do not think this is too harsh of a vacancy and leasing expense assumption. Of course it’s not unusual for a tenant to remain in a property for several years (we have a tenant who has lived in a rental property we own since 1996), but it will be prudent for you to be conservative in your approach to forecasting rents. We’ve included a reasonable and conservative rent escalation of only 3% per year and a property appreciation rate of 8% per year for illustrative purposes. Some homes we sold less than a year ago have appreciated more than 15% since then, but we of course do not know what your actual experience with rents and value appreciation will be. We think the assumptions in our example are reasonable to use, even if they do scare off a few potential buyers.
A summary of the Purchase numbers is shown in the next chart.
|Total Cash to Close:||$54,000|
Let’s look below at what your monthly cashflow might look like on this property during the first year, given our assumptions.
|Total Monthly Expense||$2029|
|Monthly Rental Revenue||$1500|
|Prorated Vacancy and Leasing Fee||$150|
|Monthly Cash Flow||($679)|
Woops! It looks like your going to “lose” over $600 per month on this real estate investment property!
Are we trying to talk you out of investing in rental property in Austin?
Why don’t we use more optimistic numbers?
We do not think rosy investment property return projections form a good basis for sound real estate decisions. Our main goal is to first and foremost make sure you have a clear grasp of the the potential financial implications of investing in Austin real estate. We are contacted by many new investors from out of state who seem unaware of how the numbers will really work once they buy a rental property.
If you aren’t fully prepared to accept the possibility that your investment property might produce negative cash flow such as shown in our example above, (especially during its first few years), you shouldn’t be buying rental property in Austin TX and we shouldn’t be trying to sell you on the idea of doing so.
Now for some better news
But hold on, this is a before-tax and appreciation scenario. Let’s look below at what happens over time and how this plays out after factoring in tax deductions, equity build-up and appreciation, then let’s see if investing makes sense for you.
|Tax Deductions||Appreciation||Equity||Total Benefit|
* These numbers are examples only and not a prediction of your outcome
So what’s going on in this chart above? Essentially, over time your negative cashflow is offset by tax advantages, equity build-up, and appreciation in the value of your rental property. The illustrations above are not perfect of course and are offered merely as an example of what a possible scenario might look like. Many investors opt for different loan products and are obtaining better interest rates that the 7% we use in our example. Many investors are renting the homes for more than our example assumes, and have less in other costs than our assumption shows.
But again, it is the less optimistic scenario that you must be prepared to accept as an investor, not the most optimistic one.
The bottom line, in our opinion, is that Austin investors who can afford larger down payments, higher price ranges, and modest negative monthly cash flow are well positioned to buy Austin real estate and hold on as the Central Texas real estate market continues enjoying healthy value appreciation. Our rents are still down 20% to 35% in many areas from the rent rates we were obtaining in the year 2001, as you can see in the 2005 Rental Summary. We believe the vibrant rental market we once enjoyed will return, but that it may be a year or two before it picks up momentum again as we are battling against the surge in inventory caused by new investors buying homes that would normally be owner occupied.
Disclaimer: You should ALWAYS consult with your accountant and attorney before purchasing investment property to learn how that activity might effect your personal financial and legal situation.