Tuesday, November 28, 2017

Misallocation of Resources in California

Figure it out, if you put your money in a savings account, you get a one percent return. Plunk a million dollars into an 8-unit condo, which rent for about $2,000 apiece (two bed, two bath), the mechanics suggest a return of about $16,000 per month or about $192,000 k per year. Plus, you have a depreciation tax deduction and management expenses to write off. With a return that great, why pay cash for the 8-unit condo? Instead, buy four 1 million-dollar condos and only put 20 percent down on each. This is actually happening in California right now. Only instead of 8 units, we are talking about 80 to 200 units in a complex.

Parents have their children living at home. This is a plus if the kids are paying off their student loans, but becomes a real problem when the kids get married. What can your kid rent on an income of 70k combined in LA or San Diego? Chasing your bride around the house nude, in mom and dads’s home has some drawbacks. So, 30K per year for housing, implies taxable earning of about 40k which is about $19 per hour. Put another way, you need a wife or roommate making the same amount to help pay the bills.

The problem that hasn’t been visible yet, is the fact that, building rentals is still in the creation stage. You don’t just go out a build a rental unit. It takes about 3 to 5 years from start to finish to process and complete the building of a structure. We are presently in about the 8th year of building rentals. Right now, there are a lot of rentals, but no renters at the prices asked.

If a land lord has 100 units and only has 50 percent occupied, he has a real problem. If the rented ones are returning, $2,000 a month, the effective rental rate for the whole structure is $1,000 per unit. Lesson one, the land lord doesn’t set rental rates, the market does. If the mortgage payment is higher than the rental returns, the investment is structured to fail.

The real issue here that people have failed to understand is that the Fed interests rate at .05% forces investing to be more creative. Rental housing in the present environment of low interest rates offers a return of about 15%. The real trap here is that building rental housing is forcing a reallocation of resources artificially, into a market that is already beyond full capacity.

So, what is happening in Kalifornia, high rental rates and a very high number of houses for sale. Its okay to put three families in one structure. What has not truly been comprehended is that housing costs for family units is pretty much constant. Raise the prices and you find two families occupying the space that one family utilized before (move in with mom and dad). It is literally absurd in places, 6 to 8 cars per house. The weird thing, is that a lot of these homes have three car garages and a car in front of every garage door. This suggests that the rental market doesn’t offer the rental deal Mom and Dad have in mind. Kids leaving the nest is a dreaded event.

Right now, there are too many high-priced homes for sale and an oversupply of rentals. Present rental rates suggest that things are just great. Units are renting for $2,500 a month with a $500 move in bonus with two months free with a year lease. This financial structure is the first step towards rent reductions.

These rental complexes are gigantic, 100 to 200 units and all wood frame. Welcome to the new ghettos of the future. The future cash flow projections from these investment vehicles will fail, and be refinanced and rented at lower and lower rates. Of course starting a fire in something this big, for insurance purposes, could send the owner to jail for a very long time.

What we are about to witness in Californai is a collapse in rental prices from oversupply. The forward projection of investing in rental real estate has hit a brick wall. The 10 to 15 percent return rate is no longer there with the surge of new rentals hitting the market. Plus, the tenants per unit is not the same anymore. Two people sign the lease and 8 people move in, with dogs and cats and stereo systems that make you want to scream. But I digress.

When you do the math, how many McDonalds employees does it take to pay the rent? More than one, maybe more than two.

Now you begin to follow the dots on retirement from my previous post. A tent and a post office box to receive your Social Security check each month of $1,400---$46 dollars a day. Retirement in the sun, what a life.

We are at a point to where the politicians have fixed all of our problems as tax payers by sheer incompetence and left an opening for the homeless people, who have adjusted the system to accommodate their lifestyle. The homeless will be oblivious to the future rental market collapse.


Sackerson said...

That's worth a re-read. Here in the UK also, lots of empty overpriced property, more being built, young people unable to afford. Perhaps we should be called UKalifornia.

Jim in San Marcos said...

Hi Sack

I sat here writing a comment and somehow it went into outer space when I went to post it last night. Not everything works as expected, my own body is a testament to that!

The real thing I have noticed about housing here and it is probably true a bit over there, Its not what it cost to own a home or a car, it is "What is the monthly payment." The whole financial perspective could change with a rise in interest rates.

As for UKalifornia, I beg to differ. The UK has character, been there I like the place, whereas a lot of Kalifornians are real characters.

Thank you for the compliment

Unknown said...

This is the first I have heard of any type of oversupply of any type of RE in any area of the country. Are you sure?

dearieme said...

Cheer up, Sacks. My morning paper tells me that a change in the law in India means that Indian families can now get enough capital out of the country that they can afford expensive flats in London.

Jim in San Marcos said...

Hi Tour Guide

The statistics don't reflect it, but there is a shortage of starter homes and an oversupply of high end homes. Retirees are trying to downsize, and at the same time, their kids come home to roost.

There is no real market for homebuilders to build low price homes. With all the regulations and fees, they would probably start at 400k. Builders have many orders for multi unit rentals that can be built for under 200K per unit.

There is a very noticeable shift from single family homes to condo rentals at the present time which appears to be artificial. People have figured it out, its cheaper to rent than to own if you want the freedom to pick up and move. Millennial's love their freedom.

If you surf Zillow locally, there are areas with almost no hits, and those with a lot of hits. This is somewhat confusing when trying to establish market trends. Not sure if there is a lot of "fake news" on real estate now, especially from a realtors point of view.

Sackerson said...

Thanks, DM, I shall hold to that comfort.

Anonymous said...

I totally agree great article spot on .it's the same all over the country I give it 2 yrs for the rents to go down .

Joseph Oppenheim said...

Note that the high tax states have the highest life expectancies....

“10. New Jersey: 80.04

9. New Hampshire: 80.15

8. Colorado: 80.21

7. Vermont: 80.24

6. New York: 80.36

5. Massachusetts: 80.41

4. Connecticut: 80.56

3. California: 80.82

2. Minnesota: 80.9

1. Hawaii: 81.15”

dearieme said...

Merry Christmas, Jim. And a Happy New Year.

Jim in San Marcos said...

Hi dearieme

Thank you and a I hope you had a Merry Christmas, and I wish you and your family a Happy New Year.

Jim in San Marcos said...

Hi Joseph

I guess I'll have to move to Hawaii for a few extra months of life;>)

Thank you for the tidbit of information.

Have a Happy New Year