Show Of Hands — Who’s Ready To Pay $20 For A Burger?

Posted @ 9:58 pm - Filed under Real Estate Investing, Purposeful Planning, Retirement, Selling Income Property, San Diego Property Owners

Thanks in advance for allowing me to take a little more of your time than usual. I felt it was an important subject. And it’s one which will impact for good or ill, most small income property owners in San Diego and places like it. Thanks again — I think there’s value here for you.

The thought hit me while I was enjoying my first $20 hamburger ever. No kiddin’, 20 bucks. It was made out of Kobe ground beef. I had to try. My wife was egging me on. It looked like a darn good burger — but a 20 dollar bill? I don’t think so. Still, I couldn’t resist finding out what a $20 burger tastes like. After all, what was the worst that could happen? I’d be out $20 for a burger.

As I was enjoying it (and I was HUNGRY because I’d been skiing that day — and since I wasn’t falling down every 30 yards, I actually skied a lot more) and began to think about products we buy that are usually in reasonable supply. In San Diego you can always find 2-4 unit properties. But staying with the 20 buck burger analogy, I wondered how many thinking investors would hand over almost 3/4 million bucks for a 30-50 year old duplex?

As I pulled the money for the burger out of my Levi’s it hit me. The difference between the Kobe burger and the $3/4Mil duplex? The burger wasn’t an investment that could help make or break my retirement.

Lately I’ve been wondering if maybe I’m the guy singing a solo in the desert. Though the majority of real estate professionals think our current market is a correction, they’ve stopped short of offering an opinion of what’s next and when.

Drawing from my experience, and by looking at what’s happening in many places in the country, I’ve developed what I think is a chronology of what might happen next in real estate. Though I can point to trends in several large markets, and have had extensive conversations with some real players in some of these markets, it’s still just my gut feel. Don’t get me wrong — I’m not saying there was a sudden moment of epiphany. I know what’s going on, and more importantly what’s not going on, and it gives me confidence in what I now believe is our near term future.

Today however, the markets investors should be most concerned with are those that may have been profitable for the last several decades, but are now at the tipping point when it comes to value.

San Diego is such a market. And if you’re currently own income property there, staying there almost surely will result in the loss of hundreds of thousands of dollars over the next several years. I’m not saying your property is going to lose value. I’m convinced the opposite is true.

Ask yourself where the demand will come from, for 2-4 unit properties priced in the $700K-1.3Mil range. You think $8 bucks for a hamburger is silly now?

How ’bout a burger for $20? (And it’s at a fast food joint.) The look on your face as you laugh at the thought of paying $20 for a burger at Mickey D’s, is the exact look you’ll see on potential buyers’ faces in the next 5-10 years in San Diego and places like it.

It wasn’t that long ago you could find a fourplex in a solid area of town for less than $200K. Today that same property sells for at least $750K, with many asking and getting over a million bucks. Of course it’s not just the price that is important to the astute investor. They look closely at the relationship between price and income. That $200K fourplex? Back then it’s annual income was about $25K or so. The price was 8 X $25K. Today if the value of that same property was $800K, its income would be no more than $50-60K or so. That’s 13.3-16 times the annual income. Are there exceptions? Of course there are. But they’re exceptions that prove the rule.

Now the investor realizes he’s not only paying four times as much as he did back in the day, but he’s getting less than 2.5 times the income. This is when it hits him. He’s not in the San Diego he’s grown to know and love — not by a long shot. It dawns on him he can no longer invest in this region. The numbers don’t even come close to making sense. And they’d have to fall back to 2002 levels to even entice him.

Sadly, this realization hasn’t hit most owners of San Diego residential income property. Until they try to convince an objective investor what a good deal their units are and get the RCA Dog look from the guy, they won’t get it.

Properties my investors acquired as late as 2003 have pretty much broken even on monthly cash flow with only 10% down. Today — that’s a bad joke. Since most investors prefer a fixed rate loan, 35% or so will be required as a down payment to avoid negative cash flow. In nearby growth regions investors are buying $1.5Mil in income property with the 35% they would have put down on your $550K San Diego duplex!

But, you say, I like to use those cool neg-am loans. Fair enough. You can now just about break even with 10% down in the San Diego market with many 2-4 unit properties. Let’s think about this for a bit. What does your future look like?

You don’t want to buy in what you consider less than at least an ok area, right? So let’s put you in a well maintained duplex for $550K in a decent area of San Diego county. Here’s your three possible scenarios. They go up in value, they stay the same, or they lose value.

If anyone but an owner/user buys 2-4 unit properties from now on in San Diego, they lose in any one of those three scenarios.

Losing value or remaining the same are self explanatory. If you invested in order to grow your capital, it wasn’t to lose or maintain value. How then does the investor lose when his property increases, maybe even significantly, in value? Let’s go back to the $550K duplex you bought this year.

Better yet, let’s go back to the $20 burger. For lunch tomorrow go to your favorite fast food place and look at the crowd, most of whom are buying burgers. How many, in your opinion, would stay if they had to pay $20?

Exactly.

San Diego’s real estate market has recovered, and has gone up quite a bit in the 5-10 years since you bought the units back in ‘07. You’ve decided it’s time to make a move, so you put them up for sale. The sales comps say they’re worth around $700K. (At less than 3.5% annual appreciation that would take 10 years.) Imagine, if you can, keeping a straight face while trying to convince a potential buyer how a 30-50 year old duplex is a ‘deal’ at only $700K! And it won’t just be the price. The rent to price ratio might even have grown worse by then. Who knows? The trend for the last 35 years has been exactly that.

And this buyer is comparing your duplex with a duplex AND a fourplex in another growing and yet still affordable region — for the same amount of capital invested.

If you own residential income property in San Diego, or anywhere like it, you are losing on two fronts. First, there are areas that will grow at a faster rate than San Diego, and offer prices on income properties that are far more appealing. Second, the demand for $700-800K duplexes isn’t going to remind anyone of $3.95 burgers.

The solution is to establish a Purposeful Plan to move your net equities to areas relatively close by, that are significantly more affordable, and will allow reasonable leverage. (I see Captain Obvious lurking nearby.)

Real capital growth in San Diego residential income property is becoming an endangered concept. Don’t wait until it’s almost extinct. You can turbo charge your capital growth rate by moving your equities to a solid growth region.

Hey BawldGuy, can we get you some $15 fries to go with that burger?

This entry was posted on Friday, April 6th, 2007 at 9:58 pm and is filed under Real Estate Investing, Purposeful Planning, Retirement, Selling Income Property, San Diego Property Owners. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.