This posting comes courtesy of Nick French of Catton Properties down the Peninsula. It has been edited slightly for brevity and includes some of my personal experience with investment properties.

During these uncertain economic times most investors are looking for the safest haven for their money.  Some thought they’d hedge the market with McDonald’s stock, which is down from $63 in December to about $51 in late January.  Others look to bonds, treasuries and some even stick their dollars bills under the mattress. 

At one time or another many consider buying rental property. Some looked at out-of-area property in place like Florida, Arizona and the Central Valley to buy speculative or rental properties. Recent foreclosure and price drops in Florida and the Central Valley has proven that this kind of strategy can be high-risk. Without proper guidance, these out-of-area markets can be scary propositions and you can lose control over what’s happening to your investment when it’s not close at hand.

With an expert on your side, however, out-of-state purchases can be effective. Cece’s first-hand experience with investments in Utah and Washington state have delivered a handsome return over the past 12-18 months. But she was wise enough to recognize that she needed proper guidance and relied on an expert that studied metro markets and accurately predicted which ones would flourish.  

Each investor is going to have a particular strategy.  Some of my clients buy homes with a view, while others buy only multi-units and others mainly downtown locations.  When considering investment property you have to take off your personal residence hat because the direction of the house, natural light, and type of roof are not generally main considerations for the property.  Instead, focus on its investment value, i.e. cash generation and growth.

The cash flow of your investment is fundamental for obvious reasons.  You want to make sure your investment is covering itself or produces a net gain for your risk.  I created a spreadsheet several years back where I plug in all of the relevant information about a property and it shows me the cash-on-cash return.  Then I can make a fairly clear calculation on whether it is a good cash property to consider.  Many investors buy property strictly on the basis of its cash flow and buy only the properties that generate the greatest cash flow return.  Today, those properties are generally out-of-state, in markets that typically often have lower growth.

I compiled a group of popular purchasing locations for rentals compared to Santa Clara County area using the annual percentage change of the housing price index provided by the OFHEO.  The data shows that the our area has greater increases than most other regions suggesting that we have the greatest appreciation over time.  But if cash flow is the strategy then you may focus on lower growth regions. 

My particular strategy is to purchase property that covers itself with twenty to thirty percent down payment in an area with an ample renter pool and allow the growth to compound my investment in a market with strong rental rates.  There is even an argument for a negative return property that has high anticipated growth. 

The growth side of real estate is a powerful investment strategy; these areas typically have stronger rental markets and rising rents.  According to BusinessWeek, in the latter part of 2007, the Top 10 rental markets on the rise included San Francisco and San Jose in the top two spots, Oakland in fifth and Orange County finishing in sixth. 

Unfortunately for those with rentals in the “bubble” areas, they are seeing the opposite happen with rents; the many speculative buyers with the one-year ARMs adjusting are frantically  competing to rent out their properties lowering the rates in these areas.  So even though the numbers looked good you don’t want to forget about the vacancy factor and rent adjustments.  Having a property in a strong rental area goes a long way to protect your investment and sanity.

Which strategy should you take and is it a good time to make your move?  Your strategic direction should be influenced by your investment tolerance, cash return and timeline.  If you are in a position where you need the cash flow for your investment possibly because you are preparing for retirement, a strong consideration will be areas with the greatest cash flow and potentially lower growth. 

If you have a longer time horizon and do not need the immediate cash you have the ability to consider the growth strategy.  Either option can be beneficial for your portfolio; analyze your options carefully, talk to professionals such as your CPA and Financial Advisor and make a sound decision.  I am not necessarily suggesting going out tomorrow and buy an apartment building, but it is good to understand these two approaches and to keep an open mind. 

The biggest shift that I am seeing in our local market is the lack of urgency to buy real estate, which I think is positive.  I work with my clients to focus on the value-proposition and not have the urgency thinking that tomorrow they will be priced out.  I will close with one of my favorite sayings that Ricky Roma so eloquently stated in Glengarry Glen Ross: “I subscribe to the law of contrary public opinion… If everyone thinks one thing, then I say, bet the other way…”

This entry was posted on Friday, April 11th, 2008 at 4:18 pm and is filed under Buying Strategies, Investors. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.

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