More new options for the small real estate investor.
Become the next Kondo King!
In New options for the small real estate investor we looked at the opportunities the downturn in real estate prices present to the novice investor these days. In that article we looked mostly at that long-time favorite of the small-time investor, the duplex. This time we'll look at investment condos.
Why condos? For one thing, they're usually newer than the typical duplex, at least in this area, where the typical duplex dates from the 1950s (or 1920s). For another, busy investors looking for the least commitment to their property usually can't do better than a condo—the homeowner's association does (or is supposed to do) the exterior maintenance (usually; always check the CC&Rs to verify maintenance responsibilities), reducing the landlord's workload to taking the occasional phone call about a drippy faucet. At least on a good day.
What's the downside to investment condos? Well, there's always the HOA dues to complain about, as in "they're reaching deep into my pocket every month and robbing me of $327, and I don't get anything from it". This goes back to the typical landlord's aversion to anything that takes away from the bottom line, such as routine maintenance. However, routine maintenance keeps property values high and, in addition, I've always thought that tens or hundreds of condo owners in a development pay less per head than the owner of a single-family home or small investment property for the services they get. Another drawback, at least to the investor wanting to build value, is that some of the easiest, most cost-effective ways to refurbish a property—exterior paint, landscaping—aren't available to the condo owner.
I might also mention that, in my experience, homeowner's associations usually don't look kindly either on absentee landlords or on their tenants, sometimes (often) with good reason. The close proximity of condo living calls for compromises—turning down the volume, not having twenty of your closest friends over for an all-night party—that not every renter (or owner-occupant, for that matter) cares to make or every landlord cares (or knows how) to enforce.
And if you're an investor looking for positive cash flow—an "income" property that actually puts money in your pocket every month—very few condos will do the trick. To illustrate this, let's take a look at a few typical condos.
Want to own an investment condo in a nice upper-middle class community like Palo Alto? Sure you do. Not only is Palo Alto a great city, but way back when I was managing rentals I found that Palo Alto tenants were invariably bright, conscientious, reasonable folks. Low-maintenance, in other words. So let's look at an affordable way for you to get into that market: a 2-bedroom/2-bath condo at one of the more affordable, but still pleasant, developments, Greenhouse. It's on the market now for about $530k. You could probably get it for a bit less, but let's use the list price as a guide to monthly operating expenses. Mortgage payments, at 6% for a 30-year fixed with 25 percent down and 1 point, would be about $2375/month. Other monthly expenses include property taxes at about $550, insurance at maybe $100, and HOA dues of $440. Total monthly expenses would be about $3450. The condo would rent for about $2100.
Okay, right away you can see the problem. You're going to "run a negative" of about $1300 to $1400 a month, before any non-recurring expenses. At this point it might be good to remind you that these expenses are deductible, up to a point—check with your tax advisor—and that there's a paper expense, depreciation, that's another deductible expense. In addition, you can eventually "exchange" the condo for a "like-kind" property of equal or greater value and defer your capital gains tax, thus using the full market value of your investment properties to expand your investment property portfolio indefinitely until you pay the tax when (and if) you cash out. Or your heirs can pay it when you check out.
But not everyone can afford, or wants to afford, a "negative" of $1400 a month. So let's leave Palo Alto and head south to downtown San Jose, an attractive area with a strong attraction to young professionals. Okay, here's an attractive 2/2 condo in a newer development right in the middle of downtown and right next to San Jose State University—I used to park my starving-student rated '61 Falcon on this very site when it was bare dirt. At a list price of $535k your expenses amount to about $2400 for the mortgage, $557 for property taxes and $100 for insurance each month, plus dues of $440, for a total of about $3500. The condo could rent for about $1900.
Whoops, that move didn't pay off, at least not if you're looking for cash flow. But wait, here's another 2/2 condo, smaller and a little further from downtown but still relatively new, listed at a mere $320k. Total monthly expenses would be about $2250, rent about $1700. Better, but still not there.
Okay, let's keep heading south, into parts of San Jose best described as "entry-level". You can also call them "cash-flow positive". Here's an older 3/1.5 townhouse listed at $143,500, with regular monthly expenses of about $1200—and a market rent of $1500 to $1600. Now we're talking. Here's another, listed at $164,900, that'll cash flow $200 to $300 a month. And another, listed at $160k, that also flows about $200 to $300 a month.
Right now you're thinking, "If this is so great, why isn't everyone buying $160k condos?" The answer comes in two parts: a) they are, and b) the savvy investor doesn't wait for everyone to be buying $160k condos, or whatever the smart investment happens to be this month. In fact, I'm beginning to realize that the savvy investors were the ones buying investment properties late last year and early this year, before bank-owned property sales took off like a rocket, multiple offers became common and banks discovered they held all the cards.
But it's still not too late, especially for the smart investor who plans to hold for the relatively short(?) time it takes for prices recover, and enjoy either positive cash flow in the meantime or something close to it, especially after taxes.