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Location, location, location. But with a caveat…

July 13, 2012 By Erion Shehaj Leave a Comment

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!

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Cranes, nail guns and the real estate investing market

July 13, 2012 By Erion Shehaj Leave a Comment

There’s lies, damned lies and statistics. With all the misinformation and spin that surrounds every release of statistical real estate data, it can be hard to tell how the real estate market is really doing. But every long term real estate investor needs to have a good understanding of where the market is at any point in time since this deeply impacts the decisions and choices she makes going forward.

Case and point: Is the Houston real estate market currently in a real expansion or is what you’ve been hearing more fluff from cheer leading real estate agents? The latest reports on real estate sales in the area show both prices and sales going up double digits year over year. But I also remember reading articles on how well the real estate market in Houston was doing right in the middle of 24 months of declining sales. Sure, we did a hell of a lot better than most other parts of the country but in the kingdom of the blind, the king has one eye.

So if you can’t trust the data interpretation, how can you tell how the market is really doing? I’ll tell you about a proven indicator that you can see for yourself today. Time for a mini road trip. Hop in your car, drive to a new home subdivision after lunchtime, and listen. Do you hear the sound of nail guns and hammers? Are construction workers framing up spec home after spec home? If it’s silence you hear, the market may be recovering from a recession but it’s not expanding yet.

Take a look at the four real estate market cycles graph below. It describes the Recession, Recovery, Expansion and Hypersupply stages that commercial real estate goes through but the principles hold true for residential real estate as well.

Remember this: There’s no expansion without new construction. Builders don’t start building again until they see real demand pick up. Take that one further: Drive around the Galleria or Midtown or Downtown? Do you see cranes? Are developers building more office buildings and luxury apartment complexes? Imagine the level of investment that Gables puts into building a new 600 unit luxury apartment complex. How much do you think they paid for that land in the Galleria? They have to know with reasonable certainty that demand for their units will be there when they’re complete or they don’t pull the trigger on the project.

That drive through Houston’s city centers or new construction subdivisions today will tell you that the real estate market in Houston has truly turned the corner. And you don’t have to take my word for it. You can see for yourself.

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Cranes, nail guns and the real estate investing market

July 13, 2012 By Erion Shehaj 2 Comments

Photo Credit: José Manuel Ríos Valiente via Compfight

The driving force behind Houston’s strong rental market

July 11, 2012 By Erion Shehaj 1 Comment

It’s no secret that the rental market in Houston has been outstanding, boosted by ever increasing demand by prospective tenants. Since 2005, I’ve seen rents increase almost 20% as properties get re-leased for higher and higher amounts each turnover. For example, a North Katy home that would fetch $1100-1150/mo six or seven years ago, consistently rents for $1350-1400 these days.

Great, so what’s behind this strong demand for rental properties that’s driving up rental rates in Houston? And most importantly, is this seven year trend just another bubble, a fluke or a fad?

The answer, as empirical as they come, was reported from the Houston Business Journal this morning. Texas jobs have now reached pre-recession levels:

Texas gained 410,400 net nonfarm jobs between May 2007 and May 2012, ranking the state No. 1 for raw change during that period, according to a Business Journals’ On Numbers analysis of U.S. Bureau of Labor Statistics data. The comparison period begins seven months before the official start of the recession in December 2007, meaning Texas surpassed its prerecession job level by a significant margin.

James Carville said it best: It’s the economy, stupid. Texas is a pro business state with a favorable business and fiscal “climate” that attracts successful businesses who create jobs. This job availability creates inward migration into the state which results in high rental demand as these folks need places to live that offer good schools, safety and amenities. So it is not a bubble or a fluke. It’s real growth with economic underpinnings – the strongest and most sustainable foundation for growth of any kind. So should you build a long term real estate investment strategy with quality assets in Texas? No brainer.

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How to retire in 7 years with real estate investing

July 10, 2012 By Erion Shehaj 5 Comments

Real estate investors’ goals vary in nature: Sometimes it’s about growing their portfolio’s value or income from it to a certain amount. In other cases though, it’s all about time. How can they achieve what they want (retirement, financial freedom, quit the job to stay home with the kids) in X number of years? How many assets do they need to purchase and what level of invested capital will be required? And most importantly, how do all the pieces fit together in a coherent strategy?

Our Blueprint Investment Strategy can answer all these questions.

As an example, let’s look at a case study. Say you have a married couple in their mid 40s with 3 kids who have a combined income of $150,000/year. Their goal is to retire in 7 years with an income from their investment portfolio of $75,000/year. Now you might ask: How are they retiring if they’re only earning half of their current income? True, but think about what their current income funds: Their retirement investments, college funds, additional savings etc. All things that go away when you actually, you know, retire. So in this case, they’ve figured out that their living expenses would be comfortably covered by this $75k goal.

So let’s think this through. Each paid off property they will own at the end of 7 years, will produce about $11k/year in pre-tax income. So they will need to own about 7 debt free properties at the retirement finish line to accomplish their desired income. At an average of $30k of invested capital per property owned, that will require about a $200k investment to acquire a portfolio of properties worth about $980k. At acquisition, each of these assets should have a positive cashflow of about $4400/year that we could use to pay off their mortgages within a 7 year timeframe. If this investor were to use nothing but the positive cashflow to accelerate the payoff of mortgages, she could pay off the entire thing in 12.5 years. Since we’re trying to get there in just over half the time, we need to add more firepower to our cashflow to make the process burn faster. So, for this investor to retire in 7 years with an annual income of $75,000 he would have to invest an additional $1,300 each month to increase the rate of debt payoff.

Usually this is the part where things get very quiet. Because it’s a cardinal sin for an investor to invest money monthly in their real estate portfolio, right? I mean, this should be an income producing strategy not an income spending strategy. Think about it this way. Your real estate investment portfolio is being used as a tool to achieve retirement. So let’s look at all the other tools you’ve been using for the same purpose. Mainly your 401(k). You invest about 14k each year in that thing don’t you? And it doesn’t even come close to producing $75k in annual income and over a million in asset value in 7 years. So explain to me, why is okay to invest that kind of money in an “invest and hope for the best” strategy that might get you to retirement at 65 but not in your real estate investing portfolio?

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What training for a marathon taught me about real estate investing

July 5, 2012 By Erion Shehaj Leave a Comment

On February 18, 2012 I ran the Livestrong Half marathon in Austin Texas. The training for this event took almost a year of early morning runs in Houston’s hot and humid summer weather. It was a transformative experience for me as I went from over 200lbs and getting winded just walking to the mailbox, to being fit and healthy again. But most importantly, in pushing myself to accomplish this goal that seemed larger than life when I started, I learned some valuable lessons about real estate investing that I wanted to share with you today.

Lesson 1: Start with a plan then show up. No exceptions!

No one gets a free pass when it comes to training for a marathon. Unless you’re a proven runner, your level of fitness is largely irrelevant. A fit person might need a shorter training plan but they have to train! Lack of training is a guarantee of failure regardless of your fitness starting point. So you must lay out a long term plan – which days will you run and how long. And this plan is designed to get you closer to the ultimate goal of finishing the big race. But the plan doesn’t work if you don’t show up and execute. Especially on the days when you feel like turning on the other side and getting another couple of hours of sleep.

Real estate investing is much the same say. Some people start with more capital some with less. Some with six figure incomes and some with less. But neither of those in and of itself will get you ready for the big event – retirement, financial freedom. You have to lay out a solid plan – what assets will you acquire, when and where. And how will you use those assets to get you ready for retirement? Then you have to show up and execute. If you don’t take the steps the plan calls for, it remains just an idea on a piece of paper. And everyone that’s ever taken a shower has an idea…

Lesson 2: Your efforts follow your goals

When I first discovered this, it was an epiphany. One day the training schedule called for a long 8 mile run. So when I went out that morning, I was mentally prepared for the distance. I would be halfway there at 4 miles then about 75% done at 6.5 then one final push to the finish. During that last mile and a half, I was so exhausted I couldn’t feel my legs and my heart was in my throat. A few days later, it was a short 3 mile run which I thought would be a piece of cake. A funny thing happened during that last mile that day: I was just as exhausted and barely finished.

Most of the limits we think we have are not physical but mental. Your real estate investing efforts and your intensity in executing them will follow the goals you set for yourself. So don’t sell yourself short. If retirement and financial freedom is what you seek, don’t settle for “buying a couple of rentals”. If you want a couple of million in net worth and six figures in annual income don’t strive for “some extra income”. First your mind, then your plan, than your actions.

Lesson 3: There will be doubt and resistance

I’d love to tell you that during my marathon training, I was 100% unwavering, eyes on the prize but I’d be lying. Actually on a pretty regular basis my mind would try to sabotage my efforts through rationalization. In one instance, I was trying to run 10 miles – a 2 mile increase from my previous high. Needless to say, when the ninth mile started, I was spent. I thought I would just shut down all of a sudden like a PC but I kept trying to push forward as the goal was just in sight. And right at that moment, this thought would come one that said: Hey, if you stop now, you’re still increasing your highest mileage by 1 mile. That’s pretty good, right? Just stop, you’ve done enough for today etc etc

Same story with real estate investing. I get phone calls from clients all the time, questioning if the plan they’re implementing is actually going to get them to retirement. Doubts are a part of human nature – we’re hard wired to question ourselves and to present resistance to forward movement. We prefer what’s comfortable. But in real estate investing, “comfortable” means sitting on the same spot you were 5 years ago with no forward progress. When the doubts seep in, it’s not time to stop. It’s a signal to push forward harder and execute your plan.
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