If there was such a thing as a real estate “constitution”, it would consist of three words: Location, location, location. It is the best known and most fundamental concept about real estate desirability. Nothing adds more value to a piece of real estate than a good location and there’s really no second place. But when in comes to long term real estate investing in Houston Texas, the old adage can sometimes lead investors astray.
Let’s take the Inner Loop as an example to illustrate my point. I don’t think anyone that knows Houston would disagree that the area inside the 610 Loop is one of the most desirable locations in town. And for good reason. The city’s cultural heart with its museums, theaters, opera house and ballet is there. So are the best parks in the city, the best entertainment venues etc. The Inner Loop is a great location because it allows its residents to have a great lifestyle. So if you live (and invest) by the “location, location, location” mantra, the Inner Loop would be a great place to acquire great real estate that will be desirable to both future buyers and tenants alike. However, there are some storm clouds in the sky of that strategy and here’s why. The ratio between the price an investor pays for the property and the annual rent the property generates is too high to make any money. In more plain terms, the higher the price you pay for a certain amount of rent, the lower your return. For instance, if you were to pay $140k for a Katy property that produces $18k in annual rent ($1500/mo) you’re paying just under 8 times rent. If instead you acquire a property in the Heights that costs you $300k which produces $30k in annual rent($2500/mo) you’re paying 10 times rent. That difference between the two means that the Katy property will cashflow very well while the Heights home will have negative amortization.
Be that as it may, negative amortization isn’t the end of the world. Pretty much every California property circa 2000-2005 had negative amortization. But it didn’t matter because the appreciation in real estate prices more than made up for the money you had to feed the property each month. For example, if a property that you buy for 400k, costs you $500/mo out of pocket over 5 years it doesn’t matter much if the property’s value would go up to 700k in that timeframe. Here’s where we run into a problem with this strategy in Houston Texas. We don’t have double digit appreciation rates here. We never have had and never will have. Our market has always been a 4-6% annual appreciation rate kind of market. So if your properties aren’t making you any money on a monthly basis and the appreciation doesn’t amount to much then where will your returns come from? Because I’m assuming you’re investing for returns, not ego, right? This would be a different situation if you were looking to purchase a property to reside in that also carries an investment component to it. But as a pure investment play, no cashflow plus slow appreciation is a bad recipe.
In addition to that issue, there’s Age. Most properties Inside the Loop are in older more established neighborhoods and they will require more attention and more hassle to maintain for a long term investor. Or, the alternative is to buy newer condos and we’ve already discussed why that doesn’t work when you invest in Houston.
So does that mean location isn’t important? Absolutely not. The principle is alive and well in our market as well. You have to look at it from the prism of what makes a property’s location great for a tenant. Based on past experience with the great tenants we’ve had on our clients’ properties, they are looking for properties in great school districts, in safe neighborhoods with plenty of amenities, with easy access to workplace, highways and shopping. When you look at it that way, most properties that fit that description aren’t Inside the Loop. Actually, the number one factor that drives tenant demand, school district quality isn’t that strong Inside the Loop.
Location is the most important factor in determining the desirability of real estate. But the quality of location for the long term real estate investor depends on what his desired tenants perceive to be a great location.
Have a great weekend!
Photo Credit: Trey Ratcliff via Compfight
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