Are Florida Condo Cash Back Opportunities A Good Investment?
Need some cashback? How about guaranteed rents, full property management, in a hot location like Orlando, or Tampa, or Phoenix?
Seems like everywhere you look real estate investors are finding deals that would have been unheard of 2 or 3 years ago. Thank the Fed and the rate cuts of the past cycle. Ironically, the Fed does not seem to be as concerned about reviving the housing market, but that's a story for another day.
When we're analyzing opportunities, we focus on three major questions:
- Is this an investment that I can carry without having to dip into my own funds?
- Does it meet traditional real estate investment success criteria?
- What are the risks to loss of investment capital?
- What are the future potential gains?
- Is this the best opportunity out there for my funds?
I. Is this an investment that I can carry without having to dip into my own funds?
Your success in real estate investing will be determined in many cases by whether you have the ability to hold on to your investment until the price appreciates.
"All investment ultimately is about emotion"
Whether you're talking about the Nasdaq at 6000, or 900, or you're talking about real estate in 2005 or today, emotion plays a huge role in the success that you have.
"Not being a particularly astute emotional investor, I overcome that shortfall by expecting to buy and hold real estate for years. And the key to being able to hold is monthly breakeven cashflow"
And the rewards from real estate investments are definitely worth it. The leverage from owning real estate dwarfs any return you make from any other investment. Real estate is the only investment available today where you can obtain 10 times leverage and get tax deductions and writeoffs.
Conclusion: The best opportunities are structured so that you receive significant amounts of cash back. If this cash is invested at a market rate of return, and with the reasonable expectation that rents will increase in future years, these investments are highly positive cash flow.
The situation generally requires deferred interest financing. Since having deferred interest pile up is not an attractive proposition we advise our clients to pay down principal separately from some of the positive monthly cash flow that is generated. This mitigates the impact of deferred interest significantly. And allows appreciation to flow to the bottom line.
Secondly, another strategy that may make sense to some investors is to take advantage of our insider pricing and relist the unit for sale at the public price in a few months, the exit strategy being to sell the unit at around current market value and pocketing the cashback incentives.
2. Does it meet traditional real estate investment success criteria?
Real estate investment appreciation is driven by location, job growth, income growth, and supply and demand. Simple as that. You want to purchase in desirable locations convenient to amenities and facilities. In areas that are experiencing solid job growth with low unemployment, good income growth.
Finally, supply and demand is tricky. Youl get better prices when supply far exceeds demand and money is always made on the purchase. But you want to purchase in areas where future demand is expected to increase rather than decrease.
Conclusion: YES, these opportunities are all in markets with robust growth prospects, high in-migration, some of the strongest job growth in the country and great urban locations.
3. What are the risks to loss of investment capital?
Preservation of capital is of primary importance. In that respect, these opportunities are solid. Condos today are the cheapest form of housing, especially condo conversions.
These projects are the sweet spot of the market, the bread and butter section. There will always be demand for condos in urban areas as young people and immigrants enter the workforce.
Demand for these units is high and will continue to stay strong for the foreseeable future as traffic in U.S. cities continues to get worse and commutes get longer.
However, there is too much supply currently in the market. It is our opinion that there will be a shakeout in the condo conversion market and some inventory will go under. However, most inventory in the stronger markets is being absorbed rapidly and should get back to balance in 18 months or so.
Once back in equilibrium, we expect prices to rise because the cost of new construction is now prohibitively expensive for developers, land is no longer easily available in prime urban areas and getting permits for building is a labor intensive and costly process.
Conclusion: While prices may stagnate over the near term, the prospects for the investor with a 2 year plus horizon are bright.
What are the future potential gains?
As discussed in the previous section, due to prohibitively more expensive newer construction, these projects will catch-up in pricing to new construction. In addition, there are hardly any new projects being announced as builders have drastically reduced construction.
Conclusion: Once current supply is absorbed, demand will ensure that these projects catch up to new construction pricing. The expected horizon for this is 18 to 24 months.
Is this the best opportunity out there for my funds?
The mechanics of this investment can be broken down into two parts. The investor receives an upfront return on investment upto 150% as the cash back is paid to the buyer within days of closing.
The best way to analyse the opportunity could be to consider this as a stock purchase.
You purchase the stock for $100, putting down $10 the rest on margin. You receive an immediate $15 in cashback, generating a 150% return on your investment within two days. In addition you received dividends or roughly 15-20% for the first two years.
For sake of simplicity, lets assume that you pay down the deferred interest using the positive cash flow and that appreciation is minimal and just enough to offset the rest of depreciation. Lets call deferred interest and appreciation a wash.
In addition to the positive cash flow, you get a tax benefit from depreciation and real estate related expenses of upto $25,000 passive income loss. At minimum, that is another $3000-5000 in income from tax credits, or an additional return on investment of 12-15% per year.
In the third year, the situation is around breakeven, but to be conservative we'll forecast a $2500 loss. Ditto year four and year five.
At the end of 2 years, assuming you sell the property at the same price you bought today, a very conservative assumption, your transaction fees on the sell side would be $13,000-18,000.
So here's a summary for a one bedroom unit:
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|
| Initial Investment |
$22,000 + closing costs = $26,000 |
| Initial Upfront Return |
$35,000 |
| Cash Flow Over 2 Years |
$7,000 |
| Tax Benefits |
$8,000 |
| Deferred Interest & Appreciation offset each other |
|
| Resale Cost |
($13,000) |
| Net Profit Potential |
$37,000 |
| ROI% |
142% |
Conclusion: If you know of opportunities that can exceed your return 142% over 2 years, then this is not the best opportunity for you. But if doubling your money and then some over 2 years, without the benefit of appreciation appeals to you then this is a good investment.
What Am I Missing?
The one remaining item that needs to be addressed is what is the true current value of these opportunities and what is the future value. In other words are developers bumping up the price of these projects to offer the cash back incentive.
Current value today is hard to pinpoint, given today's dismal market. What we do know is this:
1. The prices at which these units are being offered are the same prices or lower than what they were being offered in 2005. So the follow up question is how much have prices decreased since that time? If you believe the median home price, Orlando for instance is still seeing moderate price increases. So pricing has not come down significantly.
However there is significant discounting going on in the condo conversion market as some developers are starting to go under. So our opinion is that developers are essentially offering buyers the profit spread that they would normally have kept for themselves, and begging buyers to get them out of the project since their carrying costs from interest and some vacant units are killing the developers.
2. Due to the difficulty of appraisals in a market like this one, the cost of replacement method makes far more sense. Today cost of construction - including land - is likely in the $300-400 per sq ft area for similar land, similar quality construction.
Assuming we take a conservative stance, let's say $250 per sq ft is a very very fair estimate.
Current pricing for a unit in Orlando with 870 sq ft is $226,000. However the cost to the buyer is net of incentives, or $191,000. That works out to $219 per sq ft.
It is our opinion that prices these units are being offered at are very fair and once this down cycle is over, these prices will never be seen again.
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