Is Now a Good Time to Invest?
My investor
clients have asked this and similar questions so often
in the last few weeks that I decided to write this
article to answer the most frequent questions (which
I listed below along with the sub topics). This turned
out to be a long article (for me) so I added links
so you can click an go to the section most relivent
to you. Please remember that I am a Realtor; not an
attorney, CPA, tax specialist, investment advisor,
or visionary. I am just a Realtor who happens to have
invested in real estate and made money doing so.
Is
Real Estate Investment Too Risky?
I have personally purchased
stocks that become worthless paper but I have never
seen or heard of real estate becoming worthless. While
no investment is risk free, if you follow sound business
practices, real estate is one of the safest investments
you can choose. "Ok, but what about all the investors
who are in bankruptcy?"
What most of the "investors" where engaging in during
2004 and 2005 was not investing, it was gambling
or at best speculation. Most were betting that the
rapid rise in the value of Las Vegas real estate would
go on forever or at least long enough for them to sell
their proeprties to some one else before anythin bad
happened. If you see a diffference between that "investment
strategy" and shooting craps,
let me know because I can't. I suspect that most of
these people based their decisions on "The Secrets
of the Experts," or similar drivel. As a person who
has owned between 30 and 40 rental proeprties and made
good money on them (and deferred or reduced a lot of
taxes), I will tell you a secret, "There are no secrets."
There ar esound business practices and there is gambling.
I do not gamble as an investment and sould't either.
"But what about the peopel who bought at the wrong
time?" Here is one of the fundamental mistakes. There
is no "wrong time." There are good investment and there
are bad investments. "But what about the real estate
crash?" Unless you needed to sell, there is no problem.
Let me explain.
If you purcased a proeprty for $350,000 in 2005 with
fixed rate financing and you were able to rent it at
the time with a $150/month cash flow, you would likely
be making $175 or $200/month on that investment now
because rents have risen in the batter areas, Yes,
on paper that investment might now be worth on $250,000.
But if you have a positive cash flow or even a neutral
cash flow, you do not have a problem. You would keep
collecting the rent and in two or five years your property
would be worth more than you paid for it and you would
likely have purchased much more (with a positive cash
flow) during this period.
What was the "secret?" Only buy properties if they
make good business sense. If you can't find one that
makes sense, DON'T BUY! Rents in Las Vegas, despite
the huge increase in inventory, have not "crashed".
Below is the data.
ANd, even
if you purchased an investment property at the peak
in 2005 you would be ok IF you
followed good business practices and only purchased
at a price that allowed you to rent it successfully
then you would still be fine today. Granted, you
would likely be upside down but you would still be
renting it at a profit. What killed so many was that
they did not follow sound business practices and
over paid and took tremendous risks with adjustable
rate financing and zero down.
Real
Estate vs. Other Investments
I am a Realtor, not an investment advisor so read the
following as only my opinion and validate any conclusions
you draw with your investment
advisor, lawyer, CPA or other qualified professional.
The
Average Person Can Do It - I know
of many people who made a lot of money in real estate.
These were not people who started with a fortune and
expanded it. These are every day people like you and
me who started small and accumulated properties over
a period of years. You have to know what
you are doing but it is not that difficult. It requires
more patience than brilliance. As to stocks, I have
met only one person who accumulated wealth through
stocks and he states it was as much luck as skill.
No
Management Required -
Not only do you not want to manage the properties
you self, I strongly recommend against it. Managing
rental properties requires processes and skills that
few people have. All my clients, except one, depend
on professional property managers. The property manager
I normally work with only charges my clients 7% (compare
to the typical 10%) and is excellent at the most
critical aspect of property management: getting the
right tenant in the property. So, you can successfully
own rental property whether you live in Las Vegas
or Kathmandu since you never manage it yourself.
Low
Tenant Risk - In many states, it
can take months to get a non paying tenant out of the
property. For example, in California, if the tenant
knows what they are doing, they can occupy your property
for up to a year and never pay anything. In
the business friendly Las Vegas it usually takes takes
a maximum of 20 days. This tremendously
reduces your investment risk.
Tax
Advantages - Tax advantages are likely the
number one advantage of real estate other any other
form of investment that I know of. Not only can you
deduct expenses and losses ( there are limits) but
you can depreciate the property.
Depreciation -
Note that this applies to both US citizens and anyone
with US income. The big helper is depreciation. (See
this IRS publication for specifics).
Essentially, on rental property, you deduct 1/27.5
of the purchase price of the property each year from
your taxable income. Additionally, you can depreciate
personal property used in the operating of the property
(appliances for example) can be depreciated over a
shorter period of time. Depreciation has the benefit
of turning even relatively poor investments into cash
flow positive while, on paper to the IRS, being a loss
that can offset other income. This
is a HUGE factor.
Trades
of Like Kind (IRS 1031)– The IRS allows
you to do a trade of “like” kind. This
is a tremendous tool for increasing your holdings
and for long term tax deferment. (See
this IRS publication for specifics).
Section 1031 of the U.S. Internal Revenue Code allows
investors to defer capital gains taxes on the exchange
of like-kind properties. Section 1031 specifies that
if an asset is sold and the proceeds of the sale
are then reinvested in a like kind asset, then no
gain or loss is recognized, allowing the deferment
of capital gains taxes that would otherwise have
been due on the sale. Note that conditions and and
restrictions apply; seek professional advice before
considering a 1031 exchange. Don't you wish you could
do this with stocks?
Also, a 1031
exchange is not limited to just rental properties,
it also allows you to "exchange" rental properties
for land, office buildings, etc. A 1031 one exchange
is also an excellent "exit" strategy. For
example, over time you acquire a number of properties
but you want to retire and not be bothered with the
individual properties. Using a 1031 exchange you could
sell all the individual properties and purchase a single
tenant office building from someone offering (for example)
a 20 year "triple net lease". With a triple
net lease, the tenant pays all real estate taxes, building
insurance, maintenance, etc. and you receive a monthly
payment. It is totally passive. Who offers such leases:
food chains (McDonalds, Starbucks, Wendy's), the government
(Post Offices), drug stores (CVS, Wallgreens, etc.)
and many major companies who need buildings but do
not want to tie their money up by purchasing property.
The image below illustrates this progression.
| Leverage – With
stocks, if you have $100,000 to invest you can
buy $100,000 in stocks. If you earn a 5% return
per year, in 5 years the (compounded) value would
be $128,000. However, putting 10% down and financing
the balance you could purchase $500,000 in real
estate. The (compounded) value of the $500,000
(minus the cost of money at 6% over a 30 year
fully amortized loan would be approximately $642,000.
See right for how I calculated this. Note
that you might not agree with my calculation
method so I could be a little low or high, the
difference ($28,000 gain from a stock vs. the
$142,000 gain with real estate) is large enough
to make my assumptions not all that relevant.
The tax advantages of real estate in the
US are awesome |
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On summary, real estate has many advantages over other
investments. However, it does have some disadvantages.
The biggest is liquidity. If I own HP stock, I can
sell it today and have my money tomorrow. I can't do
this with real estate. Depending on the equity in the
property, there may be other approaches to quickly
get cash but it will never be as fast as stocks.
Expenses -
This is a section where you need to talk to your CPA
since the rules in your state, country and even your
personal tax situation will invalidate some of what
I am about to say. When I owned rental property, the
power saw I wanted was and expense as was my traveling
to inspect the property. Expenses, when the conform
to the IRS code and are properly documented are deductible
and this will safe you a lot of taxes.
If you are comfortable with my logic at this point,
I will next address the question of:
Why
Buy Investment Property in Las Vegas?
A little background - My wife and I moved to Las Vegas
a few years ago from New York City. We could have moved
to any city in the US. Why did we choose Las Vegas?
(“Sin
City?”) I am by experience and training an
engineer (20+ years with HP, IBM and Internet startups)
and my wife is an attorney. We are very analytical
people and are driven by “the numbers” more
than anything else. When we both decided to leave
or current careers, we spent a month crunching numbers
and considering options. Las Vegas was the clear
winner. Why?
Land
Shortage – Land shortage? For those
who have been here, you will remember the vast open
spaces of land surrounding Las Vegas. Fortunately
(or unfortunately) It’s
all federal land. In fact, only about 11% of the
entire state of Nevada is privately held.
How much undeveloped land remains in the Las Vegas
valley? About 35,000 acres. That is not a lot of
land with a population increase of 10% to 15% per
year. 2007
was a bad year for Las Vegas yet the city grew 12%
in population and crossed the 2,000,000 mark. See the
map below.
As you can see, there is little room
for Las Vegas to expand and a significant portion of
what is available is between Nellis AFB and
the Nellis Ordinance Test Area. I don’t know
about you but I would not want to live on the flight
path of military aircraft; just too noisy. Bottom line – the
shortage of land will increase the prices of all land
within the Las Vegas valley.
Job
Growth - Today, Las Vegas has over 6% unemployment;
mostly in construction. This is exceptionally rare
since Las Vegas has traditionally been one of the
leading cities in the nation for job growth. However,
this will rapidly change as liquidity is restored
and the large projects like City Center ($7.6B) are
completed and come online. There are three large
casino projects (including City Center) which are
scheduled to come online in 2010 and will bring
almost 80,000 incremental jobs. Plus, companies are
continuing to relocate here because of the pro-business
environment. Some of the types
of businesses that are relocating in Las Vegas include
furniture, cancer
research, Network
Access Points (NAP), jewelry,
air
freight hub, and more. Further,
there are plans in the works for a high speed maglev
train to connect Las vegas with Los Angles.
No
State Income Taxes – This
is my personal favorite; there are no state income
taxes for individuals.
A
Great Place To Live – I remember reading
about a company that planned a brilliant dog food
campaign for a new product. Everyone loved the campaign
and lots of consumers bought one can. The
problem was that the dogs did not like it. This is
true for where people live; if it is not a good place
to live and raise a family, it will not have sustained
growth. Once you get away from the strip, Las Vegas
is a great place to live. Prices are reasonable (more
so now!!!) Here, a valet or bar tender can afford
to buy a home. Also, we have 310 days a year of sunshine!
I live in Summerlin on the west side of the city
in a beautiful neighborhood with the mountains as
a backdrop. I am 20 minutes from my favorite hiking
trail in Red Rock Canyon. An hour and half from skiing,
two hours from a great national park and much more.
This is a great place to live.
Ok, you are
convinced that at least I believe that Las Vegas
is a good place to invest. But ...
Why Buy Now?
what do you call an opportunity when everyone agrees
it is a good one and lots of people have reported
making money on it? Too
Late! Right now, all the market indicators
that I can see point to this being a wonderful time
to buy; especially the bank repos. But this is true
only for select price ranges and select areas. For
most areas and price ranges in Las Vegas I believe
prices will fall further. How much have they
already fallen? Depending on the specific area, as
much as 50% in select cases.
The
Market Has Changed - Since the first week of 2008, sales of certain
price ranges in select locations are selling at record
rates. See the graph below.
As you can see, the red line (2008) just crossed the
monthly sales volumes of 2004 and 2005! However,
these sales are not across all price ranges and all
areas. The sales are hot only in select areas
and price ranges. These areas and price ranges
are the key areas for real estate investors. The
MLS subdivides Las Vegas into areas. Looking at
only one of these areas, the average sales price for
all single family homes priced less than $250,000,
the average asking price was $193,302 and the average
sales price was $196,376. Yes! The homes
on average sold for more than the asking price. The
volume and the trend towards selling above asking price
in select areas and price ranges should be a call to
action for all real estate investors.
What Do I Consider “Sweet Spots” For
Investors
Call me for the specific areas (I’ve spent too
much time on analytics and research to pass it all
on to other Realtors who read my site) but the home
profiles are as follows:
Single Family:
- In a subdivision that has a home owner’s association
and CC&Rs but whose monthly fees are less than
$50.
- 3+ bedrooms
- Has reasonable access to the strip
- Newer (2001 or newer)
- 2 car garage
- $120/SqFt or less
- $225,000 or less with seller paying your closing
costs
- Does not back up to commercial or busy roads.
- The cost to rehab is reasonable (less than $6,000)
- Area vacancy rates are low
- Not an age restricted community
- No private pool or spa
- Tile roof
- 2+ bathrooms
Condos:
- 2+ bedrooms
- Priced at $125/SqFt or less
- Has a pool and other amenities
- 900SqFt+
- Built in 1989 or newer
- $125,000 or less with the seller paying your closing
costs
- HOA fees less than $150/mo
- Not age restricted
- Not a high-rise
- Gated
- 2 baths are best
- The cost to rehab is reasonable (less than $4,000)
- Dual masters is best
Las
Vegas Rental Rates
The large number of foreclosures has resulted in a
lot of properties going into the rental market. Plus,
many of the condos (like X-It) are now leasing. With
so much inventory coming onto the market in such a
short period of time, the rental rates must have crashed
as well. A simple answer, no. See the graph below.
As you can see,
there have been fluctuations but no serious drop.
So, not only did rental rates not plunge on the rapidly
increasing inventory, most of the experts I read
are predicting a shortage of rental properties in
the near future which will drive up rental rates.
Summary - I believe that real estate
is the safest and lowest risk investment available
to most people. I also believe that now is the time
and Las Vegas is the place. If you are interested in
learning about or buying Las Vegas investment properties,
call me. You will be glad you did.
Eric Fernwood
702-358-8884
EricFernwood@Gmail.com
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