Now that the holidays are behind us and a new year has begun, the phones are starting to ring again and the email inquiries are coming in again from prospective investors who are considering purchasing investment property in Austin. The most common question we hear is, “can I buy a rental house in Austin that will provide positive cash flow with 10 or 20 percent down?”. My answer is always, “yes you can, and those are not the houses you want to buy”.
As tempting as it is to chase better cash flow, it’s not a good idea to do so in Austin in my opinion. Smart investors in Austin are looking for properties with appreciation potential first and foremost.
I’ll use a recent investment opportunity I had as an example.
An owner contacted me desperate to sell. They had drained their savings keeping up the payments on their vacant home in Kyle (having already moved and attempted to sell the home for 3 months with another agent). The CMA market value of this home was about $115K, which was also the amount owed on their mortgage. After adding sales expenses and commissions, the sellers could not sell the home and afford pay the closing costs.
This is the situation which we often refer to as being “upside down”, whereas a seller can’t sell the home for enough to walk away free and clear. If they don’t have money to bring to the closing table, they’re in a bad situation. They were about to let it go into foreclosure, unable to make the December payment and feeling completely overwhelmed and stressed out over their situation as Christmas approached. I asked if they had discussed a possible “short sale” with the lender. They said they had and that the lender was not willing to consider a short sale (which surprised me).
So here was a vacant home in Kyle, in great condition according to the owner, and ready for move-in. I could personally purchase it for $115K (allowing the seller to avoid commissions and further carrying costs) and it would rent for somewhere around $1050 or $1100. This home would provide a small positive cash flow for me with 20% downpayment and a fixed 30 year loan. It’s the slow time of year so I drove down to Kyle to have a look. In the past, I’ve bought properties from owners in this same situation, either by purchasing it outright or by taking over the payments for a year or two before selling.
The home was in excellent condition, in a reasonably decent neighborhood, and had a good one story floorplan. I have to admit, based on the fact that the cash flow numbers looked ok, I felt very tempted to buy it. But I didn’t.
The area is surrounded by vast amounts of still undeveloped land and new home neighborhoods. The opportunity for this neighborhood to experience healthy, double digit appreciation in the coming years (as is happening in the areas we recommend) isn’t very good, in my opinion. In fact, it wouldn’t surprise me if this home’s value stays flat for a while with all the cheap new construction going on around it.
But I nevertheless, for a moment, felt the same draw; the lure that many investors feel, toward the better “on paper” cash flow a home like this can potentially provide. I’d have to pay $140K to $160K for a house in area 10 that will rent for $1050, and here was one I could pick up relatively easy for $115K.
Why not do it? Because cash flow isn’t as important to me as potential appreciation. Also, the paper cash flow could easliy be undone with an extended vacancy and/or an expensive turnover or two. In a couple of years I could potentially have gone in the hole on a home worth little more, or not much more, than what I paid.
I walked away.
The experience did help me better understand the powerful draw that these homes with better rent/sale ratios can create for investors. I felt it. Then my mind started trying to rationalize away the rules of thumb I preach and obey. “It’s only $115K” I thought. “Someday this area will have to appreciate” I further thought. “I’d be helping some nice people out of a real jam – I’d save their Christmas” the little voice said.
Then I remembered the last time I broke my own rules on an investment purchase. That mistake resulted in the worst real estate loss I’ve ever experienced when I purchased a 10 unit apartment building for cash in a scrubby little town about 3 hours away from Austin. I knew better on that deal too, but talked myself into the deal with mindtalk similar to that above, and ended up getting hosed. But that’s another story for another day.
As investors, we have to pick the real estate investment strategies, formulas and criteria we believe will work best for us personally, and then we have to possess the discipline to stick with those rules and formulas that we put into place for ourselves. One of my rules is to avoid starter home neighborhoods such as this one no matter how good the cash flow might appear to be.