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

Following up on our work in CRS 204, this is a short rundown on investment opportunities in the Metropolitan Phoenix area. What we offer, compared to higher-priced markets, is an affordable entry into viable rental homes that can show a positive cash flow from the first day. In the analysis I did for the class, I was working from a real house that was chosen from a particular set of assumptions. The goal was "autopilot" landlording for an out-of-state investor. Other business models are also very exciting.

The classroom example is 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%. Because the entry cost is so low (and it can be much lower, of course, with or without PMI), we're doing another very similar home next Thursday.

This is not pie in the sky. The houses selected for this business model are based on a very strict set of criteria: The Western suburbs of Phoenix, recent builds, 3 bedrooms, 2 baths, all-tile roofs, etc. This searchBot coughs up possible candidates, but only in a general way. (Note that the search results are dynamic; through time, houses will move through the sales cycle from Active to Sold.) On-site, I'm 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 I want is for "my" houses to be the first choice of every tenant who sees them.

Why the Western suburbs? Because they're a good fit, for now, between lower-priced, newer homes and a short commute into Greater Phoenix. Even better, a brand new hockey stadium has just been built in the area, and a brand new football stadium is under construction. Both of these attractions will be surrounded by vast tracts of commercial development, creating huge numbers of new jobs.

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 I use an elaborate lease addendum to bind the tenant to doing most of the low-cost maintenance. I purchase a home warranty for my landlords, and the tenant agrees to pay the $50 deductible on higher-cost repairs. The ideal is to do the work of landlording between tenants, not during tenancy.

What about marketing? My 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. The "for lease" listing for this home is here, and my intent is to aim right at the marketing factors that are missing from competing listings. 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. In consequence, getting too far above $145,000 has negative cash flow consequences, for now at least.

Finally, the numbers in the 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.

Other business models...

I like this business model, and it is explored more fully on my investments page, but there are a lot of other ways to make money in the Phoenix housing market. Fix-ups abound, for example, with room to take an $80,000 "needs help" to a $110,000 "starter home." For landlords who don't mind investing more effort (or paying a property management company), there are a lot of turn-key homes in the low 100s that can attract a long line of tenants at $800 a month. That $1,200 rent ceiling (excluding luxury neighborhoods) yields a negative cash flow on houses at $160,000 and above, but some neighborhoods have such high apprecation, 10% and up, that the long-term yield can still be very good. And we haven't even touched on multi-family or development opportunities.

On the other hand...

The Arizona Republic casts doubts on all these assumptions in its June 16, 2004, edition. In fact, there will be no California- or Nevada-style price boom in the Phoenix area. We have vast tracts of undeveloped land, no land-use restrictions, and a very well-prepared builder community. There seems to be no limit to how far new home buyers will commute in order to get the home they want at the price they can afford. But: This does not apply to renters: Cheaper homes in places like Queen Creek or Surprise are not good rental homes, despite the low entry cost. No nearby jobs or amenities, no tenants. But the key point in the Republic's litany of doom and gloom is the notion of people being "priced out of the market." What do we call those folks? Oh, yes, we call them tenants.

Bottom Line is the bottom line...

Phoenix is the fifth largest city in the United States. The Metropolitan Phoenix area houses 3,000,000 people now, and we will grow to 8,000,000 in very short order. In other, pricier markets, you or your clients might be able to buy one rental property a year, with a negative cash flow that you hope will be covered on the back end by appreciation and tax benefits. In Metro Phoenix, that same money will buy three or more homes a year, each one with postive cash flow from the first tenant and each one looking more enticing to outsiders with every snowflake that falls in the Great Lakes. No one can promise investment results, but a smaller risk per investment and a spread risk-load make those three Phoenix-area homes seem very attractive compared to that one big risk back home. Better yet, an uncontested eviction in Arizona takes 20-25 days, not the months and months it takes in other states. And, to make everything even sweeter, inspection trips to the Valley of the Sun become partially tax-deductible!

So..., let's get to work...

I'll pay a referral fee of 20% on any transaction referred by a CRS 204 classmate. So send me your clients. If you explore my web site, you'll see that I take very good care of the people I work for. But send me yourself, also; I'll pay a referral fee to you, too. I was deeply impressed by the class (my first CRS class), and I'm delighted to be working with such eager, active minds.

Very best wishes,

Greg Swann
GregSwann@BloodhoundRealty.com
602-740-7531

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