Investing in Phoenix, long-term or short, offers vast potential

The forecast calls for snow, back East, up North, and as long as it does, the Phoenix/Scottsdale-area will probably be a growth market. About three million people live here now, but our carrying-capacity is at least eight million. We build new homes as fast as we can, but rarely fast enough to meet demand. No one can promise future appreciation, but there are very few real estate markets with as much enduring promise as Phoenix. Whatever your investment goals, we will deploy our experience, our technology and our thoughtful intelligence to help you reap the most and the best of the profits the Phoenix market can provide.

What kind of results can you expect?

We've been going through the same down-turn in values as the rest of the nation, but we have a built-in baseline demand from the Great Lakes and other snowy regions. And we seem to be experiencing a steady increase in our long-term in-migration from California.

At our normal rate of 6% annual appreciation, single-family residences in the Metropolitan Phoenix/Scottsdale market are an excellent investment.

In the following table, we're looking at the same one real $225,000 house in five different down payments with two different assumptions about average appreciation over the next eight years. This is a real house that we sold recently, with all costs, taxes, rents, etc., being based on the real numbers. We've held rents flat (at $1,050 a month) and vacancy high (at 10%), even though, in the long-run, rents should go up and vacancy should go down. We are extremely rigorous about real-life numbers, so you know exactly what you're getting into. If anything, we want for our numbers to be more pessimistic than reality, so that your real results turn out to be happier news than our projections.

If you click on the down-payment percentages in each scenario, a five-page spreadsheet will open showing you every last fact and projection leading to our conclusions. CFBT is your projected annual cash-flow before taxes. CFAT takes account of the cash-flow after you have deducted losses and depreciation from your tax liability. Yield is the net annual after-tax return on your initial outlay. Since you will probably be selling your investment properties by IRS Section 1031 tax-deferred exchange, your actual Return and Yield numbers could be higher; this is a topic to discuss with your tax professional.

What this table makes abundantly clear is that positive cash-flow, except with a very hefty down payment, is very difficult to achieve. But if you can absorb a negative cash-flow from other sources of income or with a negatively-amortized loan, you can still build long-term wealth in the Phoenix residential real estate market. And at $160,000, a newer suburban home like this can be cash-flow positive, which means it will self-amortize regardless of short-term market performance.

(There's a lot more that we bring to the table as investment Realtors, but, just as an aside, that financial breakdown and this analysis is sufficient reason for you to make an appointment to meet with us or to pick up the phone and dial 602-740-7531. (Outside of Arizona? Dial 1-800-508-5430.) You simply will not get better information from another Realtor. Plus which, we do this a lot. We are very experienced, and we have a cadre of very talented partners--lenders, inspectors, property managers, etc.--to call upon.)

But we're very far from being done. Here is an example of a fully thought-out investment plan:

A snake-oil-free
investment strategy...

What we're working with is a set of assumptions about viable investment properties. There are other investment ideas out there. Flipping is one, for example, buying distressed properties at a deep discount, refurbishing them, then selling them at or near their fair market value. Slumlording is another, buying very low-priced properties in challenged neighborhoods and collecting lower rents while making minimal property improvements.

What we've been looking for are homes that can appeal to the premium tenant--not rich, but reasonably prosperous and more likely than not to make sure the rent gets paid on time. Because we are marketing to a population of out-of-state investors, we aim for properties and tenants that will require a minimum of "landlording"--minimal maintenance effort and cost and minimal collection problems.

The investment goals are diverse: Cash-flow first, of course, but the kinds of properties we're talking about will throw off less cash than a Slumlord's rentals. Rents should rise steadily year-by-year, but so will maintenance costs. Depreciation comes next, the well-concealed friendly side of the tax laws. After that comes tax-deferred income: Using the IRS Section 1031 exchange laws, you can defer your capital gain on your properties until retirement, when your income tax rate may be much less. But the best investment benefit of owning rental homes in the Phoenix-area is long-term appreciation. No one can promise future appreciation, but Phoenix has offered a fairly steady 6+% return since the end of W.W.II. In recent years, appreciation has been much higher. Over the last year, it has eclipsed 65% for the kinds of homes we're talking about.

Think about this: If you purchase and rent out a $225,000 home in the western suburbs, with a 20% down payment, your total monthly outlay will come to around $1,250. If you can rent that home for $1,050.00, you'll take a small cash-flow loss: around $200 a month or $1,200 a year. Don't get too excited, though: You will have vacancy. We're going to strive to pick properties that will rent faster than the market generally, but some of your cash is going to be eaten up between tenants.

But the structure (not the land) is depreciable: You can write off $6,545 per year as depreciation on an asset the IRS presumes will be all used up in 27.5 years. ($225,000 x 80% / 27.5 years. Your mileage may vary: Confirm this number with your accountant.)

(Because you suffered a net cash-flow loss, this, too, will have tax consequences, which you should also discuss with your tax adviser.)

If you 1031 out of that house and into another one, or into another real estate investment, you don't have to "buy back" your depreciation and you won't pay any Federal income tax on your capital gains until you "cash out", sell without doing another 1031 exchange. (Again, confirm this with your accountant.)

But here is where the money is: For $45,000 out of pocket (plus closing costs, if any, and vacancy and maintenance expenses), you gain control of an asset worth $225,000. At 6% appreciation, at the end of one year that home will be worth $238,500. At two years, it will be $252,810. After eight years, the home will be worth $358,616, a gain of more than $300,000 on your original investment of $45,000. Plus you will have taken a substantial amount of money off of your income tax liability. The net benefit will be huge, and you will still have the house, either to produce more benefits or to use in a 1031 exchange to buy something else.

Please understand that no one can promise you future investment returns, but even a relatively anemic appreciation rate will throw off investment benefits that could sextuple your $48,500 seed money over eight years.

Even better, in many cases, you will not have to put 20% down. Most investors can qualify for 5% down programs, often without Private Mortgage Insurance. Ideally-qualified buyers can go in with nothing down. With seller-paid closing costs, you can acquire an income property for less than $2,000 out of pocket! Why does this matter? Because the greater your leverage, the greater your annual yield. Higher debt service payments will results in lower or more-negative cash flow, but your ultimate cash-on-cash yield can be astronomically higher, fifty or sixty percent per year, after taxes, compared to fifteen or twenty.

But however you finance it, rental real estate is potentially the highest-yielding low-risk investment available to you.

The homes discussed above are unearthed for us by a search tool called the Invest2Bot. The original InvestBot was devised for a California couple investing in Phoenix precisely because rental housing in California was prohibitively expensive. A revised version of this search engine was dubbed the Invest2Bot, and this has been iteratively modified to suit the needs of out-of-state investors.

What kinds of homes does it search for? Newer, single-story, 3 and 4 bedroom, 2 bath homes, 1200 - 1600sf, stucco exteriors, tile roofs, with garages and back-yards, loosely situated along the Freeways in the suburbs of Phoenix.

Why there? Because those are high-growth areas with significant job growth (for example, on the west side two new professional sports stadiums are being built, each surrounded by vast commercial enclaves), better schools, and reasonably-priced homes. The Invest2Bot identifies homes that are at least in principal appealing to premium tenants and which can sell at prices low enough to make them at least marginally profitable, in cash-flow terms, from the outset.

Even then, an Invest2Bot home is not a guaranteed slam dunk. We're doing things to promote profitability and limit liability. For example, we search only for homes with tile roofs, on the theory that a tile roof has a much longer useful life than a shingle or foam roof. We avoid homes with backyard pools, since these invite costly liability lawsuits.

There are other factors: We're looking for homes that are nice, but not too nice. Improved but not over-improved. Acknowledging that there is bound to be some damage to a rental home, we want for it to be cheaply- and easily-repaired damage.

But after all of that, we have to look at the home on the ground, to see its condition and to gauge the value of nearby amenities: Schools, parks, shopping, etc. What we're looking for are homes that are likely to be more appealing to tenants than the typical random rental. We want the homes we pick to rent quickly and at the highest attainable rents.

We publish a daily hotlist of Invest2Bot homes. You can subscribe to this list, if you like, at no cost. If you make an appointment with us, we can take a tour of the best available homes, previewed and filtered for viability. In other words, we will only look at homes that seem to offer the best long-term prospects as profitable rental investments.

Investing in Metro Phoenix: Affordable luxury with a manageable commute...

Here is an actual real-life case-study of an Invest2Bot home. The goal was "autopilot" landlording for an out-of-state investor. You can find a detailed rundown on the financials of the transaction here, in full battle array. Here are the Cliff's Notes on that transaction: We closed on 6/15/04 on a resale home in Avondale, AZ, for $130,000, with the seller contributing $1,000 to costs. At the end of 8 years, my client should turn an initial outlay of less than $30,000 into a little over $85,000, an after-tax return of 14.27% and a before tax equivalent return of 19.82%. (In fact, through the first fourteen months of this investment, the home had appreciated by around $100,000, more than 56%.) Because the entry cost is so low (and it can be much lower, of course, with or without PMI), there is practically no limit on how many of these you can do..

This is not pie in the sky. The houses selected for this business model are based on a very strict set of criteria: High-growth suburbs of Phoenix, recent builds, 3 bedrooms, 2 baths, all-tile roofs, etc. The Invest2Bot coughs up possible candidates, but only in a general way. On-site, we're looking for features and amenities that will make the house stand out in the prospective tenant's home search: Proximity to jobs, to schools, to playgrounds, utility of the floorplan, ease of maintenance, etc. What we want is for "our" houses to be the first choice of every tenant who sees them.

Why these suburbs? Because they're a good fit, for now, between lower-priced, newer homes and a short commute into Greater Phoenix. Why newer homes? Because this business model is built around the idea that an out-of-state landlord should be able to self-manage these properties with little day-to-day involvement. Tenant selection is the key factor, of course, but we have an elaborate lease addendum to bind the tenant to doing most of the low-cost maintenance. We purchase a home warranty for our landlords, and you can write the lease so that the tenant agrees to pay the $45 deductible on higher-cost repairs. The ideal is to do the work of landlording between tenants, not during tenancy.

What about marketing? Our frank opinion is that rental housing in the Phoenix area is pretty poorly marketed – which just means there is an opportunity premium for doing a better job. Ultimately the right house will sell itself, but good marketing can hurry that outcome.

The purchase price range we're using puts us in the middle to upper-middle of the tenant population. There are a lot more tenants to draw upon in homes that can rent for $800, but both the tenants and the houses can require a lot more management. The tenant pool tops out at about $1,200, since people who can pay more than that can qualify for some loan on some home, even if that home is not as nice as your rental.

Finally, the numbers in the above example are real. I used a round number for insurance, but my client's actual number was lower. I used $600 a year for maintenance, even though the home warranty costs much less and the tenant and the deposits should cover the rest. And I used a 10% vacancy rate, which conforms much better to average time on market in the areas we're talking about. In fact, I expect this kind of carefully selected home to rent much more quickly than a random rental.

What about 2-, 3, or 4-plexes?

Somewhere in California there is a seminar mechanic convincing investors that there is a fortune to be made in 2-, 3-, and 4-plex properties in Phoenix. There isn't. The claim is either an error or a hoax, but it is not an investment strategy. Small multi-family properties can be cheap to buy, per unit, but they will still be cheap when you sell them. They are found in lousy neighborhoods that do not appreciate. The tenant pool is huge, so vacancy is never a problem--but evictions and damages are. They should throw off positive cash-flow, but it will never be much. Compared to the single-family residences discussed above, very small multi-family properties are a lousy investment. If you have a huge pile of 1031 cash to bury, they you might do well with a large apartment complex. But for the ordinary small investor, the single-family strategy discussed here will work marvelously well and the 2-3-4-plex hoax never will.

But what about condos?

That's a differenbt story, or at least it may be. Because we've had such huge appreciation over the last year, many first-time home buyers have been iced out of the single-family market. They are assiduously buying up condominiums, town-homes and patio-homes, which have until very lately been the ugly step-sisters of the Metropolitan Phoenix housing market. Because owner-occupants are bidding up the value of these homes, there is an opportunity for inestors to ride this appreciation escalator up, just as with single-family residences.

But wait, there's more...

That's just one way of profiting from real estate investment in the Phoenix area. We will be delighted to help you evolve your own investment strategy – the same deep level of thinking in the service of a different objective. We have sources of 'hard' money for flipping, for example, and in the longer term we have plans to assemble teams of investors to buy or build big things.