Investing in real estate when real estate is expensive
Finding a new way to play an old game
As I am sure many of you have read over the years, real estate can be an exceptional investment if held over the long term. At one time my family was in real estate, so I've been hearing that since I was a kid. When I was 14, my Dad put a copy of "How I Turned $1000 into Five Million in Real Estate in My Spare Time" on my desk, and I was immediately enthralled with the relative simplicity of real estate investment, it's tangibility, and the access to leverage it enabled.
Despite being written in the sixties (and the obvious lack of a professional editor), the book is highly relevant even today. It was one of the first detailed accounts of what is now a highly documented -maybe even over-documented- strategy:
- Buy a crappy house
- Add elbow grease and as little money as possible
- Either sell it for a profit OR
- Rent it out and borrow against the increased value in the house to buy another
- Rinse and repeat with increasingly more elaborate properties
The fact that this book was written so long ago, and there are STILL people doing this every day, shows you that it can be a very successful strategy if implemented correctly. OK, yes, there was that slight hiccup ten years ago, but generally, prudent investors can do well with this method of real estate investment.
What about those of us who live in expensive cities who can't even buy a crappy house?
First of all, this post is NOT going to be about the strategy above. Just type in "real estate investing" in Google and there will be a thousand decent articles. Instead, I am going to focus on an alternative, but very closely related, strategy that I have started to pursue for myself.
The problem centers on the obvious. If, like at least 50% of America, you live in an expensive urban agglomeration like Seattle, Chicago, Miami, etc, even a complete tear down in an investment grade neighborhood will set you back at least $500,000. For SF, LA and New York... it's way more.
The problem is, these cities are awesome for real estate investment. They have growing, dynamic populations, rising high-dollar employment, and often urban redevelopment is already underway. Although you can buy a house in Kansas City for $100k, or a lot less, the lack of growth or dynamism in the local economy means that your investment will never really take off.
It's impossible to get on the traditional single family home housing ladder in these cities, even in a two income household with $200k+ yearly income. It doesn't leave much room to start.
Condos: another option
If houses are too expensive, then townhouses and condos are really the only option. It's true, there are some negatives like HOA fees, but at the end of the day you can still find a cheap condo, fix it up, and make money either selling it in a flip, or renting it out. Condos also happen to have some unique positives, especially for investors like me with limited time.
- They ARE cheaper as an entry level price point. By this I mean the cheapest condo you can find will be significantly cheaper than the cheapest house (in the same general area). For instance, on the day I am writing this, the cheapest house I can find in San Francisco is $600k. The cheapest (unsubsidized) condo I can find is in the $300k region. Admittedly, both of those listings are in awful neighborhoods, but the point is valid across the city.
- No outside maintenance concerns, which are usually the expensive and scary ones
- Often, utilities and other hassles are bundled by the association into the HOA
- They are simpler to fix up
Many people get hung up on the HOA, which I really don't understand. If you buy a house, there is maintenance that is accumulating every day that will eventually need to be paid out and fixed. Who wants a gigantic lump sum surprise expense? In a well run condo association, that number is predictable, monthly, and generally small enough not to grossly affect the math. My theory is that most people would prefer a large expense at some undefined point in the future rather than a guaranteed small expense every month, forever. I'm the opposite.
What would we look for in a neighborhood?
Finding a good neighborhood is the first step, and the things I'd look for in a neighborhood are higher level versions of the things I'd look for in a condo itself. Redfin makes it even easier to narrow down. I'm going to use San Francisco as the example in this post, but you could easily do this for any city. In fact, you can use the same Tableau Public visualization here, and update with data from your city. I'll fill you in on that later. What are we looking for?
- Prices are rising, or stable. Look at history over the past year to two. Hopefully, prices are going up. Regardless of your intent, buying into a falling market isn't a great idea.
- Find a neighborhood with a large difference between high priced properties, and low priced properties. This way, the purchase price is lower, and the potential gain in equity (or sale price) will be much higher
- Other tangible and positive things to pay attention to include planned redevelopment nearby, new or expanding employment opportunities, and extensive public transport, or plans for public transport.
As always, it's a little more fun to see this visually.
Realistically, most of the most expensive zip codes are going to be difficult to get into at a low(er) price point of $600-$800k. I know, that's not a low price point, but it is an achievable number for significantly more people than a SFH in the $1.2-$1.8m range. With high priced zip codes like 94109 (Marina) and 94102 (Nob Hill) out of the running, and lower priced ones generally less desirable, that only leaves a couple of neighborhoods in the running.
- 94107 - Mission Bay and Potrero Hill
- 94115 - Pacific Heights
Mission Bay and Potrero have a significant amount of redevelopment going on now, which is only going to improve the neighborhood. On the other hand, there are fewer older condos in need of redevelopment, so it's harder to find the "right place" to get into. Pacific Heights is a little more expensive, and as you can see from the visualization above, but it has an enormous range in sale prices, from around $800 sq. ft. to $1250 (looking at the bands, rather than the whiskers in the box plot). That, combined with the generally older age of the housing stock should make it easy to find a place that needs some work. In the next post, I'll outline the process of finding the right house in the right neighborhood.
Condos are a great alternative to traditional SFH real estate investing in expensive cities. The fact is that they're the only option available at an even quasi-reasonable price. The most important thing is finding a great neighborhood, which you can do on your own by following the steps below to duplicate the Tableau Public visualization above.
- Download Tableau Public (completely free)
- Download my workbook above and open in Tableau Public
- Download data on your area from Redfin via CSV (it's at the bottom of the pane on the right)
- Drag and drop that CSV on top of Tableau Public, this will connect to the data
- Go to a sheet in Tableau Public, right click on the existing data source in the top right, click replace data, and then select your CSV
- You're done! Start finding a neighborhood.