Property Types – What Should I Buy?

Equity Appreciation vs. Cash Flow

We wish we had a nickel for every would-be investor that said, "I´d like a 2000 or later constructed property close to the University of Texas, fully leased, and cash flow positive."

Our response is, "we´ll be happy accommodate, if you have a $200,000 cash down-payment ready!"

The reality on the ground, of course, is that a real estate investor (like any investor) must make some sacrifices and do a little picking and choosing when it comes to property investment. The key is to make the right sacrifices, and not to apply lessons learned in another market that may not necessarily fit this market.

Based on our years of experience working with investors, here is what most investors prefer, in order of importance:

1. Cash Flow – this is of course the primary reason investors invest; if they wanted to spend outrageous sums of money for negative cash flow, they´d be investing in California (or Arizona, New York, Nevada, etc..)
2. Appreciation – the appreciation seen in the U.S. from 2001 to 2006 has in some cases created unrealistic expectations about property values. Regardless, appreciation is a vital factor in real estate value.
3. Location – most investors prefer, all other things being equal, to own property in more affluent areas adjacent to prestigious universities, landmarks, and job creation engines (eg, tech firms)
4. Year of Construction – thanks to less-than-scrupulous hawkers of "pre-construction" and new construction condominiums and single family homes in primarily Florida and western U.S. markets, many investors believe new construction property to be the most important investment factor (and they couldn´t me more wrong)
5. Property Type – many investors believe single family homes are the best investment because they will appreciate the fastest, given what they´ve seen in other markets. Other investors stick religiously to "fourplexes only", believing that more units is better since it cuts down on the risk of vacancy. In Austin – neither investor is correct.

We like to draw a picture for our investment clients, with a beautiful new construction mansion in a wealthy area at one end of the scale (illustrating high equity appreciation potential), and a dumpy fourplex in a working class area of town on the other end of the scale (cash flow).

The single family "mansion" in Austin will cost perhaps $500,000, and due to the fact that most renters in Austin don&t make investment banker sized incomes, may earn $2,000 to $2,500 per month in rental income. With today´s prevailing interest rates, such an investment would require a huge down-payment to be cash flow positive, and though the investment would likely see significant equity appreciation, all other things being equal, the investment would not be a wise one for most investors due to the significant negative monthly cash flow while awaiting the ultimate equity return.

On the other hand, the fourplex in the working class area of town looks great on paper. It may be priced at $200,000 and be generating $2,100 per month in rent. However, a closer look at the history of the property will show that it has turned over 2 or 3 times the last five years, has a headache inducing amount of deferred maintenance, takes months to lease, and suffers from renters bouncing checks, skipping rent all together, or crowding ten residents into one rental unit.

The best investment, of course, is somewhere in the middle. Here´s what we help our clients look for:

• Jobs! – there is no single more important factor in choosing an investment property than its proximity to where people go to work or school day in and day out.
• Socioeconomics – we´re a socially liberal company, and not embarrassed to admit it. That said, we feel that it is important to choose investment property in areas where tenants are able to pay rent on time each month, and whose lives allow them some free time to maintain their units. In some rougher areas, it´s a fact that more tenants do not take as good care of the buildings, and sometimes don´t pay rent on time. All other things being equal, we´ll avoid these areas when it comes to choosing investment property
• Purchase Price to Rents – A fully leased property with great tenants isn´t necessarily a great investment if its price is so high that it will always bleed negative cash flow. Castle Hill Investments spotlights great areas of town where investors can still relatively expect to make money each month after expenses.

For most investors, a 120 x [monthly rents] factor should be sought. For those seeking higher equity appreciation, and are less dependent on monthly cash flow (ie in high paying careers), a 140 x [monthly rents] or higher factor may be appropriate.

Next Page: The Duplex – the Perfect Central Texas Investment?