Seeking Higher Ground

 

At some point in 2017 I considered buying a house in the Highlands area of San Mateo. I know this, because I recently came across an old list of comps from the area. All were sold in mid-2016 and mid-2017.

Out of curiosity, I revisited them all. 34 out of the 38 have not changed hands, and one was pending for its first sale. The other had two sales, and the last is so strange it warrants a column of its own. Given all the hype in the press about housing prices, would it surprise you to know that a full 10 out of the 34 are predicted (by the website Realtor) to have appreciated 20% or less in the last 5 years? If you remove the cost of the commission at sale using a discounted broker (call it 4.5%) the number bumps up to 13.

What about the upside?

The best projected return on a property was, at first glance, a whopping 60%, or about 12% a year, which is along the lines of what optimists say. Once you take out the commission, it drops to 53%. However, the property was purchased at a low price because of the abysmal condition. Even if they had only spent $200 a square foot for full renovations, which is optimistic, to say the least, it brings their basis from 1.6 million to just about 2.05. Now the projected return on the money is a hair under 20% in 5 years, which is a somewhat less glorious take home rate. The lowest projected return was 7% after commission over 5 years.

The second best rate of return was for a similarly unrenovated Eichler, purchased for $908 a square foot and a total price of 1.625. After a commission, the expected return is 46%, which isn’t all that bad if you like it a little retro. Otherwise, you have to start hoping a buyer rewards you above market for your improvements.

One comp sold on April 28 of this year for $2.55. It previously sold for 13% over ask, or 1.8, on April 19, 2016. Assuming no other costs (HA!), this is a return of about 635K, or 35% over 5 years. However, if it had sold for the Redfin estimated value of $2,242,713, that would be down to 19%. Throw in there the fact you were most likely paying more for your home per month than you would have in rent, the notion that this is your most valuable asset you can't go wrong owning becomes even murkier.

 

Update on My Favorite Comp (on Maple Street)

If you don’t want to overpay in real estate, it is important to know your objectives and your hold time in advance as much as possible. What are you trying to achieve? This answer is as various as the bids received. What is important is to not allow what might be a rational bid to someone else distort your view of what you should have spent on that asset.

What is most interesting to me about a comp is the story behind the data, as well as how that one little puzzle piece fits into the macroeconomy. Most transactions are unnoteworthy. They are part of the median, and regulate the data when the outliers threaten to trash its logic.

Which brings me to one of my favorite comps - as if I could pick one.

Nothing brings out the voyeur in me quite like a high-end flip. For one, they tend to set the market. Two, it is like HGTV live.

So it was that in the spring of 2017 a house for sale in San Mateo caught my eye. Sold for 1.65 at the end of September of 2016, it had been rehabbed within an inch of its life in a mind boggling six months and relisted at 1.995 at the end of March 2017. It went pending within two weeks and closed in nine days for a huge (at the time) 2.4 before the end of April. The home was immediately listed for rent on Craigslist for 6K a month.

This is all so delightfully juicy.

First, let’s start with the flipper, who absolutely knocked it out of the park. The work was perfect for the discerning buyer, whether homeowner or investor. The school district was very desirable. The buy price was judicious and under ask. The sale price didn’t go overboard. If their work timeline was a sprinter, it would be Usain Bolt.

With a total hold time of less than seven months they took in ¾ of million dollars. Unless one goes too hard on the high-end finishes or personal style front, which they did not, anyone generating a gross return of 100K a month is probably making a decent money.

On to the buyer…

At that moment in time, 2.4 was an astounding price for a single family home on a corner lot of a busy street, hot school district or not. Beyond that, the time pending gives you another bit of information, because nine days is not the speed of an underwriter. Only cash closes like that.

The rent requested for this gorgeous home, 6K, was under market - designed for a quick rental and stable tenant. This indicates an investor wants to treat the asset more like a bond than an equity. They found a tenant at that price with ease.

Looking at the math:

Cost = 2.4

Annual costs on cash with a tenant paying all utilities include tax and insurance

 

 

Tax: Max 30K a year

Per the Internet, taxes have been running about 30K a year. However, we cannot truly understand the tax cost of the buyer. The urgency of the bid suggests a 10-31 swap, which gives a buyer a very limited window in order to identify a property. Such a bidder has an incentive to ‘overspend’ in order to ensure they preserve an important tax advantage.

Insurance: Roughly 6K a year

Assuming no costs on the house for a few years given its updated status (HA!), and no property management fees, which is questionable for an investor with enough sophistication to go flinging 2.4 million around, the best-case scenario for the cash flow on the investment at 30K per year of tax would be 3K a month, or 1.5% on their money. If the owner instead paid 10K a year on tax, this perks up to 4.66K a month, or about 2.3%.

As for the so-called market value of the home today?

After a roller coaster of valuation predictions, Zillow reckons it is a hilarious $2,415,981.

Oct 2017 – 2.23

June 2018 – 2.14

Dec 2018 – 2.075

Feb 2018 – 2.4

Sept 2020 – 2.26

Jan 2019 – 2.045

June 2019 – 1.84

June 2019 – 2.75

Oct 2020 – 2.24

Mar 2020 – 2.91

Jul 2020 – 2.27

Final Answer?

No one knows. Unless the investor gets bored of the cash flow, can’t rent for an extended period of time, or suddenly needs to access the capital behind what has to be one of many financial instruments they have available by selling alone, we aren’t going to find out anytime soon.