Monday, July 28, 2014
PLACERVILLE, CALIFORNIA
99 CENTS

Making the case for buying a rental property

By
July 22, 2010 |

Democrat columnist

Saul and I had been meeting every Wednesday morning for nearly a month to preview listings. He already owned a nice home in El Dorado Hills and wanted to buy a rental in Folsom. Each week he would pick out a few listings he wanted to preview and I would check on their status and make the arrangements for previewing. Like many investors, Saul believed property values were more likely to go up than down. Last month, in Sacramento County, one in four home sales were purchased by investors like Saul, who believed property values had reached bottom. In addition to Òmarket timing,Ó Saul had several good reasons for investing in real estate at this time. Saul retained a slight trace of his ancestral accent but a lot of the old world common sense values. It was fascinating to listen to SaulÕs axioms.

ÒLook I know IÕm not going to make a fortune with one rental,Ó he said. ÒBut right now there is no better place to put my money. Always remember; never play another manÕs game.Ó

Saul was disappointed with the interest rates banks were paying on CDs and he had lost more than he had made in the stock market. Commodities were too volatile and the yield on long-term bonds would be quickly eroded by any future inflation which he believed resulted from large federal deficits. A rental would provide him with consistent cash flow and a fair return on his investment.

Saul would shake his index finger at me and say, ÒThis always happensÉ with catastrophe comes opportunity. This housing recession will be good for small rentals. Even when things recover, more families will decide to rent a home rather than buying one.Ó

Saul believed that people have long memories after sustaining significant financial setbacks. He reminded me that the lessons learned and vivid memories from the Great Depression lasted two generations.

The popularity of home ownership has understandably been declining for the last few years. A recent survey by the California Association of Realtors found only 50 percent of respondents thought owning a home was a good idea. Home ownership, which was such an integral part of the American Dream, has turned into a nightmare for many. Thousands of Californians have been financially devastated by the drop in their homeÕs value. Many have been forced into bankruptcy and foreclosure. ItÕs not likely that group will have found memories of Òhearth and homeÓ any time soon. The economy may take a few years to fully recover but the physiological impact of millions of foreclosures and devastated home values may last a generation.

Poor credit will also prevent millions from buying a home in the future. FICO Inc. released a report last week showing 25 percent of all consumers Ñ nearly 43.4 million people Ñ have credit scores below 599. The number of Americans with deteriorating credit is likely to increase before it gets better. The Labor Department is reporting 26 million people are either out of work or underemployed. California has 2 million people out of work and twice that many underemployed working part time.

Currently, home mortgages are nearly impossible to obtain with less than a 650 FICO score. In the future, that minimum score will likely increase as the housing market recovers. Bankers have long memories. ItÕs unlikely they will repeat their excessive exuberance for lending to the marginally qualified. Years from now, when politicians speak of Òopening home ownership opportunities to the underserved,Ó bankers will quickly remind them of their past folly. Both major political parties have dropped Òincreasing home ownership opportunitiesÓ from their platforms.

Saul said, ÒPeople have got to live someplace and they have too much stuff to fit into an apartment.Ó

He was right again. Most homeowners who lose their home through foreclosure or short sale are not moving into a 900 square foot apartment. ItÕs easier to downsize a house payment than eliminate our treasures. Property managers are reporting strong demand for single family rentals; most often from former homeowners. Despite the current political correctness of Òsmart growth,Ó given a choice, families will always prefer renting a single-family detached home rather than an apartment.

Saul once told me, ÒIÕm buying today to minimize yesterdayÕs loss.Ó

He explained that his home was probably worth $100,000 less than what he paid for it in 2005. He figured it would take years of steady appreciation for the value to return to his original purchase price. While he was waiting, the rental property he purchased today would be steadily appreciating Ñ offsetting some of the lost appreciation on his home.

Once when I brought up the topic of tax shelter with owning rental real estate, Saul shook his head and said, ÒIÕm not interested in depreciation. Buy cows that give milk. Show me the money!Ó

The purchase price was $240,000 all cash. I figured the buyerÕs portion of closing costs to be $3,000. The property had been rented for the last two years at $1,500 a month, which I verified with a local property manager, was at or below market rents. There were no home ownerÕs association fees. The property taxes based upon the $240,000 purchase price would be $3,000 a year, insurance would be $500, and I assumed $100 month for property management and another $50 a month for general maintenance reserves. Total yearly income was $18,000, total expenses were $5,300. The property would net $12,700 yearly for a 5 percent return.

I asked Saul if he was prepared to be a landlord. He said, ÒDonÕt open a shop unless you are prepared to smile.Ó Good advice for business and life.

Ken Calhoon is a real estate broker in El Dorado County. He can be reached through his Website at www.kencalhoon.com.

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