Monday, July 10, 2006

Reading Between the Lines in "The Hunt"

There's a column in the NY Times Real Estate section that is always amusing, called "The Hunt." They tell the home-hunting stories of a variety of people, with photos of the places that didn't work out and the final home sweet home they ended up with. The people profiled are a diverse bunch, but sometimes I think they have a preference for sweet young couples from out of state who come to New York with more stars in their eyes than dollars in their pockets, and want to rent large, sunny apartments in Manhattan for under $2,000.
This week's subjects sort of fit that mold, though they seemed a lot more realistic in their expectations than some. But here's the part of the article that stopped me:

The Coopers definitely wanted to buy a place. The two, who met in 2003 while working for a company that ran after-school programs, already owned one home: a four-bedroom house in Dublin, Calif., near San Francisco, that they bought for $530,000 when they married a year and a half ago. They are happy with it as an investment. (They now rent it out for $1,800 a month.)

Does that sound like the kind of investment someone should be happy about? If they financed 80% of the price, they'd have to have an interest rate of less than 3.25% for their mortgage payment to be covered by that rent. I don't think they could have gotten that kind of interest rate without taking an ARM with a pretty short initial term, so their monthly payments are bound to go up soon. (I'd guess their rate is actually higher than that, so they are already losing money every month and it will only get worse.) If their payments are less because they put more than 20% down, I'm still not sure the ROI would be worthwhile. I suppose they are getting some tax benefits by deducting the mortgage interest, or depreciation of the property, but would that be enough to break even? I don't know the whole story, of course, but I'm not sure what else could possibly make that house a "good investment" in today's market!

5 comments:

James L said...

maybe they are happy with it as an investment because they feel the house has appreciated a lot, but they only have to "pay" (difference between rental income and actual cost) a small monthly amount to build their equity??

i think what was dumb was selling the loft in WNY for 8k more than what they paid for it. Not even enough to pay for closing costs.

Dorkydad said...

If they are truly "happy with it as an investment," it is only because of 1) the home's appreciation -or- 2) their need to reduce adjusted gross income (AGI) for income tax purposes.

The Coopers may be breaking even cash-flow wise while taking a tax loss on their home in Dublin, CA.

Interest-only mortgages are based upon LIBOR, and a year ago June, the 1-year LIBOR rate was at 3.8632%. If the Coopers put down 20% and had an 1-year LIBOR interest-only mortgage, their monthly payment would be $1364.99 (until it re-adjusts to the current LIBOR rate as you pointed out). If I'm calculating this correctly, the property taxes should be around $50 per month. And assuming ~ $100 per month for insurance, the Coopers may have positive cash flow of $285 per month.

If my numbers are correct, then because of depreciation, the Coopers will be taking a tax loss on this property despite having positive cash flow. In addition, any trips back to Dublin, CA where they visit friends will be deductable as long as the stated purpose of the trip is to check on their investment.

Rental properties can be great investments.

Anonymous said...

$530,000, in a risk-free bank account earning 5% guaranteed interest, gives you a return of of approx. $27,000/ year, which is $2,250 per month.

Although you have to pay taxes on this, you avoid paying property tax and insurance, and the work and cost of maintaining the property.

$1,8000/month rent on a $530,000 property is a losing proposition. People have been fooled by a temporary abnormality in the housing market, in which negative cash flow was compensated for by high levels of home price appreciation. Those days seem to be over now, and there is some evidence that prices are actually declining a little now.

Anonymous said...

oops, meant to say $1,800/month rent on a $530,000 property is a losing proposition. $18,000/month would be unfathomably excellent!

We're in a housing bubble, folks.

-anon 7/10/2006 6:15 PM

mOOm said...

This is normal for CA it seems. Remember the 1% property tax and other costs too... The only way it can make sense as an investment is if prices rise. Which they aren't at the moment any more.