As everyone knows, we are in a weird housing market. I could talk about reasons that this market has come about. But I'd rather talk about some of the facts on the ground that Buyers and Sellers are facing.
Interest rates. They're finally coming down. Mortgage Nuggets newsletter says 7.09% is the average for a 30-year fixed conventional loan right now. Freddie Mac's Primary Mortgage Market Survey says 7.22%.
For an investor buying a 400k property with 20% down, that's about $2,650 per month excluding Landlord Insurance (about $2,775 counting insurance). A solid investment property at the 400k price mark will bring about $2,670 in rent. After leasing and management fees, many investors will see about $400 per month in negative cashflow.
In other words, the tenants will be paying 85% of the mortgage in this scenario.
A 40% down payment could be the break-even point for a 400k investment renting at $2,670 per month. That is, it will break even after factoring in mortgage, insurance, leasing and management fees.
Many buyers are canceling contracts. Many houses on the market have been under contract and returned to active status. Buyers enter the process not realizing how large their monthly payment will be (if their agent and/or loan officer hasn't prepared them for the new reality).
As a result, while inventory of resale homes is low, there are as of December 2023 thousands of homes that have been on market more than 30 days.
The opportunity for rent-and-hold investors is better now than it has been since Spring 2022.
Another issue that works in your favor as an investor: owner-occupiers are avoiding houses that have obvious repair issues. Typical owner-occupier buyers are low on cash, unable to come up with closing costs and down payment and still have enough cash reserves to make repairs.
Finally, what about the future of mortgage interest rates. It's a guessing game, but experts are saying the Fed will probably not raise rates at their open markets committee meeting December 13 (Housing Wire, Nov 30 report). And many think rates will fall to 6.75% by Quarter 2 (Bright MLS, 2024 Housing Market Forecast).
If the rate drops to 6.75%, that will save more than $100 per month on 20% down for a 400k property (compared to current rates).
First, let me report some good news about mortgage interest rates. They've been coming down the past few weeks. As of November 24, 2023, the average 30-year fixed mortgage rate is 7.32% (Mortgage Nuggets Daily).
Second, the not-as-good (for investors) news is that sale prices have shown no sign of decreasing. Yet. Houses and townhouses and condos and multi-family buildings in Metro Atlanta are more expensive than ever.
Third, the seasonal good news is that December and January are a time for possible savings on the purchase of a resale home. There are homes right now that have been sitting on market for months (in spite of low inventory!).
Why are they not selling?
There are fewer buyers (primarily because of mortgage rates). Many sellers have the idea they can sell like it's 2022 (the crazy market for sellers ended Spring 2022). So some sellers have put fixer-uppers out on the market—at full price as if they were move-in ready homes. Some sellers have listed their homes at a price above the market. After months of zero-success, however, there is an opportunity in this slow buying season for those who want to find a bargain.
So, to prepare for this article, I spent 30 to 45 minutes perusing available homes in a few areas I know very well. Finding a good investment (which I define as minimum 8% gross rent ratio) is harder now, but not impossible.
I found a lovely 2006 home in Gwinnett County, in the city of Snellville, for 400k—but it has been on the market for over a year!
A 400k house would need to get $2,700 in rent to beat the 8% gross rent ratio threshold I am looking for. With some improvements, this home will rent for $3,000.
But there is no reason to pay 400k. Having been on market for over a year with no change in price, I feel confident this home could he obtained for less than 400k. For the purpose of this exercise, I will say I think we could get it for 385k and spend 15k on improvements—flooring and paint.
To calculate Gross Rent Ratio, I consider the total cost of acquiring the house, which would be 400k (385k plus 15k in improvements). Anything $2,700 or higher in rent would make this a solid investment. Let's assume we could get at least $2,900 in rent.
After leasing commissions and management fees, the average monthly income for the owner would be $2,426.33. In the second year, if the tenants renew, the average monthly income increases to $2,547.16.
With a 20% down payment on 385k, the mortgage with property taxes and homeowners insurance would be about $2,687.
So there would be $260 per month in negative cashflow. But another way to look at it is that the tenant is paying 90% of the mortgage. A solid investment. Factoring in the tax benefits of owning real property, that negative cashflow will more than be made up for on your annual tax return (perhaps the subject of a future report).
The answer is YES. Even in this tough market for investors, profitable investments can be purchased.
"Hey, Derek, let's sell the property." Landlords sometimes see that their investment property has appreciated in value and feel it may be the time to sell.
And what Realtor wouldn't jump at the chance?
Well, hold that train for a minute. Of course, I'll list the property if that is the owner's desire, but sometimes selling is not the best idea—if you have a Golden Goose.
There are plenty of good reasons to sell. You need the cash to make another purchase. You are at retirement (or early retirement) and want to cash out. The market could be changing and you want to sell before price reductions happen. Or the property is not performing well. All good reasons.
But a Golden Goose lays golden eggs. And before you sell it, consider these points . . .
A good rent-and-hold property is laying golden eggs for you. You can sell the goose for a lot of money. But you won't get any more eggs.
I use a measuring stick for residential rental properties, the Gross Rent Ratio (annual rent divided by total acquisition price). For example, a client might purchase a home for $320,000 and spend $40,000 on improvements. That's an acquisition price of $360,000. If the home rents for $2,600 then the Gross Rent Ratio is 8.7%.
I try to help clients find investments with 8% or better Gross Rent Ratios. In some markets, this may be impossible. But 8% is the gold standard (for a healthy Golden Goose).
One situation that tempts an owner to sell is when repairs start to become costly. In some cases, this is because the landlord avoided capital improvements and opted for short-term solutions rather than long-term. I've had owners who bought a house during the crash (2008-2010) for 50K and they're getting $2,000 in rent (a 49% Gross Rent Ratio!!) who want to sell it because the siding and HVAC need to be replaced.
If you're making a 49% Gross Rent Ratio, you have one heck of a Golden Goose! Spending 30k to repair a home that is performing that well is a financially sound decision.
In fact, if you're making 8% or better, you have a well-performing investment. If there is still a mortgage, someone else is paying for it. If the mortgage is paid off, you're getting some amazing cash flow. Hopefully you put some of the golden eggs into savings to pay for new HVAC or siding or roof or whatever is needed to keep the goose going strong.
Just throwing out some food for thought. Maybe Thanksgiving is a good time to talk about a Golden Goose. I mean, if your rental property is a Turkey, selling is a good idea.
Let us know if you have any Turkeys you'd like our help with or if you wish to engage our services for your very own Golden Goose!