BBQ Capital | Kansas City Real Estate Investing

The real estate market just got more interesting.  The stock market is in for sure turmoil Monday through Friday of next week.  What am I talking about?  Well, buckle your seat belts, it’s about to get bumpy. 

On Friday IndyMac Bank, for all practical purposes, shut down by the Feds.  It will re-emerge Fed run.  But, boy…  Keep in mind that IndyMac Bank was at one point in time the second or third largest writer of mortgages in the country.  And not too long ago! 

What will this mean to you and me?  Well one thing it well definitely mean is that the stock market is in for a wild ride on anything financial on Monday.  I’m going to refuse to check out what few stocks I have.  I just really don’t want to know.  Now, before you accuse me of burying my head in the sand and/or having a Pollyanna attitude you need to know that I am 43 years old.  There is plenty of time for my blue chip stocks to bounce back.  Besides, I don’t have that much in the market anyway.  Mostly in houses.

As for your and my real estate investment properties I’m gonna urge you to read Friday’s post about Buy & Hold Real Estate Investing and keep the big picture clearly in focus.  If you bought on proper economic fundamentals for your rental properties you should be more than able to hunker down and survive through this next 6 months to two years. 

And if you still have cash on hand beyond your reserves I really want to urge you to make a plan to buy and possibly buy again in this next 6 months.  People are feeling panicky.  Some are worried values will continue to slide.  And they may very well.  Though I suspect you can buy smart enough to cover any possible dips and really set yourself up nicely for the long haul.

Of course much of this depends on your age, earnings, savings and overall investment plan.  So make sure you talk to your professional.  If you don’t have one, contact me today so we can find out what is best for you.

Yesterday I addressed those of you who may be stuck in the “No Sell Zone” of real estate investing.  I’m not gonna recap it here other than to say that we were looking at what happens if you are actually losing money on your real estate investments today.  By losing money I mean your yearly outgo is exceeding your yearly income. 

I’ve worked up a scenario below to show you that it’s not all that bad.  You can and will survive.  You may not make as much money as you hoped.  But it’s called investing.  Nothing is guaranteed.  (Keeping in mind that you probably bought on quasi-fundamentals to begin with.)

The Ground Rules
Below is just a worksheet example.  Obviously, you should not misconstrue this to be advice aimed at you or your situation without the competent advice of a real estate investment adviser familiar with your situation, your CPA or your attorney.

Also, we are gonna say that this buyer was thrilled to buy a $170,000 duplex in January of 2006 with 10% down at 6.5%.  His PITI works out to be roughly $1239/mo and he’s thrilled because he collects $1,350/mo in scheduled rents.  (I said scheduled.)  But he nor his REALTOR ever took into account vacancies, utilities when vacant, repairs, cost of handyman, advertising and other miscellaneous costs of owning investment property that totals up to about $2,800/yr. 

We are NOT figuring any rent increases for 5 years and then we lock it in at a 5% increase for the remainder of time.  (Are you still with me?  I’m trying to be ridiculously fair to the most pessimistic of our readers.)

And even though there is still appreciable growth in many areas of KC (no, I’m not kidding) I’m taking a “nuclear winter” approach here.  You’ll note the decrease in values followed by modest growth potential in the last few years of 3% and then 4%.  (Historically KC goes about 4.8%-5% a year.  Do the math.)

Lastly, we are NOT even going to take into account depreciation.  Or the additional tax benefits of owning rental property. 

Value Of Sample Investor’s Duplex
2006          $170,000                          
2007          $170,000
2008          $166,000
2009          $165,000
2010          $169,000
2011          $174,000
2012          $179,000
2013          $186,000

His year 1 through 5’s expenses run $17,668/yr.  ($14,868 in PITI and $2,800 in misc. expenses) and his income is $16,200/yr resulting in a net loss of $1,468/yr.  That’s a net loss of $7,340 over the 5 years.  Remember that.

Now in 2011 his rents increase 5% limiting his losses to $658/yr.  Over the 3 years that totals $1,974 and when added to the $7,340 totals $9,314. 

And since I generally recommend (case by case basis, people) in Kansas City exchanging your real estate investments every 5-8 years lets say sales costs are gonna run 6.5% off the 186,000.  So what do we have?

Sales Price             $186,000
Cost of sale           $ 12,090
Total of losses      $    9,314
Remaining loan balance  $135,645
Original equity       $17,000

Capital Gains        $11,951

See.  It wasn’t all  that bad.  If you had taken that original $17,000 and put it in a CD at your local bank at 5% per year you would have avoided a lot of trouble and headaches and risk but also only incurred a capital gain of about $8,117. 

Keep in mind we didn’t figure all the tax benefits along that way that would more than compensate you for your trouble.

Do I know when this correction period will end?  No.  Can I tell the future?  No.  But I’ve laid out a fairly bleak projection here and you still came out ahead.  And that’s if you bought too high.  What if you bought now when you have some leverage?

The “No Sell” zone.  It’s that place between what your investment property is worth and what it will take to break even on the sale.  You probably bought at the top of the market a few years back.  You may even have an adjustable rate mortgage getting ready to “adjust” which almost always means it’s going up.  (Yes, yes, yes.  I know about the LIBOR.)  You almost certainly bought on quasi-fundamentals.

“If the rents cover my PITI, I’m good.”

But you forgot to take into account other expenses your rental property would generate.  Ac/furnace maintenance.  Cleaning carpets.  Vacancies.  Roof repairs.  Lawn maintenance or painting.  Utilities when he place sits empty.

Now home values may have become flat in their growth.  Or even worse, maybe your investment property’s value has decreased 1%, 2% or even 4%.  (Hey, some real estate agents I know are working with folks who have lost 15%, 25% or more.  Quit complaining.)  The investment property is now costing you about $2,200 a year more to maintain that your rents just covering the PITI.  Now what do you do?

Selling is a tough proposition because of the real estate fees and high inventories.  You’d have to bring significantly more to the table than that $184/mo you are currently losing. 

My advice?  Hang tough.  Maybe for the next year.  Maybe for the next 5 years.  Let’s look at a horrible possibility.  A worst case scenario.  We’ll do that tomorrow.