Why I Just Passed on a Positive Cash Flow Investment Property in Austin

By
Real Estate Agent with Crossland Real Estate

Now that the holidays are behind us and a new year has begun, the phones are starting to ring again and the email inquiries are coming in again from prospective investors who are considering purchasing investment property in Austin. The most common question we hear is, "can I buy a rental house in Austin that will provide positive cash flow with 10 or 20 percent down?". My answer is always, "yes you can, and those are not the houses you want to buy".

As tempting as it is to chase better cash flow, it's not a good idea to do so in Austin in my opinion. Smart investors in Austin are looking for properties with appreciation potential first and foremost.

I'll use a recent investment opportunity I had as an example.

An owner contacted me desperate to sell. They had drained their savings keeping up the payments on their vacant home in Kyle (having already moved and attempted to sell the home for 3 months with another agent). The CMA market value of this home was about $115K, which was also the amount owed on their mortgage. After adding sales expenses and commissions, the sellers could not sell the home and afford pay the closing costs.

This is the situation which we often refer to as being "upside down", whereas a seller can't sell the home for enough to walk away free and clear. If they don't have money to bring to the closing table, the'ye in a bad situation. They were about to let it go into foreclosure, unable to make the December payment and feeling completely overwhelmed and stressed out over their situation as Christmas approached. I asked if they had discussed a possible "short sale" with the lender. They said they had and that the lender was not willing to consider a short sale (which surprised me).

So here was a vacant home in Kyle, in great condition according to the owner, and ready for move-in. I could personally purchase it for $115K (allowing the seller to avoid commissions and further carrying costs) and it would rent for somewhere around $1050 or $1100. This home would provide a small positive cash flow for me with 20% downpayment and a fixed 30 year loan. It's the slow time of year so I drove down to Kyle to have a look. In the past, I've bought properties from owners in this same situation, either by purchasing it outright or by taking over the payments for a year or two before selling.

The home was in excellent condition, in a reasonably decent neighborhood, and had a good one story floorplan. I have to admit, based on the fact that the cash flow numbers looked ok, I felt very tempted to buy it. But I didn't.

The area is surrounded by vast amounts of still undeveloped land and new home neighborhoods. The opportunity for this neighborhood to experience healthy, double digit appreciation in the coming years (as is happening in the areas we recommend) isn't very good, in my opinion. In fact, it wouldn't surprise me if this home's value stays flat for a while with all the cheap new construction going on around it.

But I nevertheless, for a moment, felt the same draw; the lure that many investors feel, toward the better "on paper" cash flow a home like this can potentially provide. I'd have to pay $140K to $160K for a house in area 10 that will rent for $1050, and here was one I could pick up relatively easy for $115K.

Why not do it? Because cash flow isn't as important to me as potential appreciation. Also, the paper cash flow could easliy be undone with an extended vacancy and/or an expensive turnover or two. In a couple of years I could potentially have gone in the hole on a home worth little more, or not much more, than what I paid.

I walked away.

The experience did help me better understand the powerful draw that these homes with better rent/sale ratios can create for investors. I felt it. Then my mind started trying to rationalize away the rules of thumb I preach and obey. "It's only $115K" I thought. "Someday this area will have to appreciate" I further thought. "I'd be helping some nice people out of a real jam - I'd save their Christmas" the little voice said. 

Then I remembered the last time I broke my own rules on an investment purchase. That mistake resulted in the worst real estate loss I've ever experienced when I purchased a 10 unit apartment building for cash in a scrubby little town about 3 hours away from Austin. I knew better on that deal too, but talked myself into the deal with mindtalk similar to that above, and ended up getting hosed. But that's another story for another day.

As investors, we have to pick the real estate investment strategies, formulas and criteria we believe will work best for us personally, and then we have to possess the discipline to stick with those rules and formulas that we put into place for ourselves. One of my rules is to avoid starter home neighborhoods such as this one no matter how good the cash flow might appear to be.

Posted by

Steve Crossland, REALTOR, MPM
Crossland Real Estate
http://CrosslandTeam.com
(512) 327-3900

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Rainer
153,905
Shannon Moore
Green Lion Realty - North Port, FL
Realtor, Sarasota & Charlotte

Great story that makes a lot of sense! I always say go with your gut.

Interesting that you are from Austin. Many of our local investors say they are looking into buying in the Austin area. They claim that's where the next "hot spot" will be. If I get any confirmed buyers I'll send them your way. It seems as though you really have some real smarts to ya :)

Feb 13, 2007 11:21 AM #1
Rainmaker
536,364
Lynda Eisenmann
Preferred Home Brokers - Brea, CA
Broker-Owner,CRS,CDPE,GRI,SRES, Brea,CA, Orange Co

Hi Steve,

Thanks for the info. 

I think your right on track.

I made a mistake a mistake myself on some units I purchased, and it was also a learning experience for me.  In Southern Ca. people have been buying (for some time now) properties based on appreciation, because nothing pencils out... but that too has changed, in our ever changing market.  Now it appears many people here are investing in your area, including agents in my own office. 

So tell me, are you are still currently seeing double diget appreciation in your area, or are you talking about the near future?

Thanks!

Feb 13, 2007 11:40 AM #2
Rainer
27,763
Steve Crossland
Crossland Real Estate - Austin, TX
Austin TX Real Estate

Hi Roxanne and Shannon - Yes, Austin is very popular with investors now. We really try to get them to stick with our thought process though, as I described above. Most, however, (not the ones we work with) head to the outlying areas in search of the better cash flow, and we let them go do that with someone else.

 Funny thing is, one of our Property Managers called Sylvia yesterday wanting a rough CMA on a property his owner bought a year ago in Round Rock in Tera Vista. The owner/investor was hoping it had appreciated by $40K and, is ir had, he wanted to sell. Our CMA shows it's not worth a penny more than the $217K he paid a year ago. Too much new construction still going on.

Lynda, regarding double-digit appreciation, yes, 2006 was a great year. I have a full writeup here and a pdf with Austin sales breakdown by MLS area 2005/2006 here. Many areas saw double digit appreciation, mostly the closer in areas we encourage investors (and regular buyers) to stick to.

 

Feb 13, 2007 02:12 PM #3
Anonymous
Anonymous
Anonymous
Excellent example of sticking with your gut.  My brother rents in Austin currently, if they decide to buy I will definitely refer them to you.
Feb 13, 2007 03:34 PM #4
Rainmaker
333,199
Thesa Chambers
Alpine Real Estate - Bend, OR
Principal Broker - Licensed in Oregon
you were wise to identify what was the investment you were looking for.  That is one of the hardest things to do... set your goal... and do not think with your heart.
Feb 13, 2007 06:17 PM #5
Rainer
99,630
Kaushik Sirkar
Call Realty, Inc. - Chandler, AZ
Steve - question from a different angle.  Should you actually have the home put on the market and see what happens before you offer to purchase?  Apologize if you had already mentioned thta in your article and I missed it....
Feb 13, 2007 06:31 PM #6
Rainer
27,763
Steve Crossland
Crossland Real Estate - Austin, TX
Austin TX Real Estate

> Should you actually have the home put on the market and see what happens before you offer to purchase?

 Hi Kaushik,

 I couldn't list it - they were upside down. I ended up referring them to a short sale specialist, who told me even though the bank had told them they wouldn't do it, that he had worked with that bank before and they would. They ended up getting out from under it after all.

Buying homes from sellers direct, as a Realtor, is tricky. I've done it many times but always way above board, even to the point of making the Seller consult with an attorney. I won't do it unless it's a win/win.

Steve

Feb 13, 2007 09:19 PM #7
Rainmaker
231,566
Christopher Watters
Watters International Realty, LLC. - Austin, TX
Austin Real Estate (512-298-4010)
Steve, I think your right on track. Being an Austin realtor I hate meeting with home owners out in the Kyle & Buda area because so many of them are upside down. Primarily because there is so much undeveloped property there and home values are not appreciating!
Mar 24, 2008 11:32 PM #8
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Rainer
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Steve Crossland

Austin TX Real Estate
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