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Monday, April 17, 2006

Walking The Market Down

The tale of an RE investor who got a little too frisky and is now walking the market down, courtesy of her blog:
November 4, 2005 - Palm Springs investment house is ready for sale after renovation. The pot of gold at the end of the rainbow:
Here's the break down:

$475,000 purchase price
+ $75,000 improvement costs
= $550,000 total investment

$699,000 listed at
- $550,000 invested
- $40,000 commission, fees, opex
= $109,000 profit

Of course, we're hit with some hefty capital gains tax, but all in all a tidy ROI for less than three months of work.

We are confident that we can sell it in the 699 range based on current inventory, comps, demand, etc.
December 13, 2005 - Hmm:
I guess we didn’t take into account just how seasonal and second home oriented that Palm Springs happens to be. Forget about a “flurry” of activity. Aside from a few curious neighbors, the traffic during the last few open houses has been basically non-existent. And it’s not just our beautiful re-do. Many of the other homes that went on the market around the same time are patiently awaiting new owners. I think we all have come to the conclusion that we have to reset our expectations. The place isn’t going to sell until after the snowbirds arrive in January or beyond.
There are a lot of totally rude and uncalled comments, but a couple of pieces of very good advice - cut your price now and move it quickly.

January 17 - Minor Technical Difficulty:
My investing strategy has been to buy rental properties that cash flow positive. This means, my loan is at a 30-year fixed rate and the rent generates more income than the expenses of maintaining the property.

The other strategy is to buy and repair fixers to sell at a profit. We bought the fixer because we demonstrated a certain level of skill with renovating our primary residences and wanted to try one as an investment tool. By doing it with another couple, we were able to mitigate some of the risk and at the same time see how we worked as a team for future projects.
With this in mind, we took the advice of a few and dropped our price by $30K. We are now more in line with the average price of the neighborhood instead of being one of the higher priced homes.
Okay, but one of the commenters posts a bunch of Palm Springs houses with much lower prices. I'm sure they are not as nicely redone as her offering, but affordability counts and in a down market you do not get back the full price of your renovations.

April 10, 2006 - The green has turned to red:
We have lowered our price twice… currently the house is listed for $629,000. At this point we would break-even or lose money. We’re all prepared for this scenario. Of course, it is disappointing but there aren’t any other options.
Anyway, we think our price is in now in line with the market. Many of the comparables that readers mention are homes that really don’t compare… we are in tune with the neighborhood and there have been one or two (redone fixers) that sold in the mid to high sixes in the last few months. There are just fewer buyers these days.
If we couldn’t afford the risk then we would be in trouble, but this is why we did the project with four people. Worse case scenario… the house doesn’t sell (even at a loss) and we can’t get it rented… then we write a check each month and enjoy our weekends in Palm Springs... end of story.
The investment has turned into a liability. Here's the advice this nice lady did not take in December, and it came from a blogger named Robert:
My advice would be to price for quick sale, work with the broker to trim commissions as well and take any offer that produces a profit no matter how small. Heck, capital gains eats away anyway. It's an investment not a validation of ones' worth as a person, not a sure thing. In this market holding on 'til spring looks more like a desperate Vegas let it ride bet rather than a sound financial decision. Look at the possibilities:

1. Sells for $699k in April. 4 more months of payments subtracted from loses.
2. Sells for $620k now. Awesome profit, no downside.
3. Doesn't sell for $620k in April. Loses and downside.
4. Doesn't sell. Rent at a loss.
I'm not posting this to laugh at this lady, but to show why it is good to clear out early and not hang on. If you can't meet your costs by holding it and renting it, the cost of holding investment properties is a down market only grows. If you are caught this way and can afford to do it, the trick to getting out is to price the property in the bottom 20% to 25% of offerings and move the sucker. In a slow market a lot of realtors will accept decreased commissions, so you can compensate a bit that way.

If you try to stay "competitive" you are much less likely to sell. So that 10% at the top just isn't significant compared to the carrying costs. With at least 17% of the RE sold in the last few years being in the "second home/ investment home" category, there's going to be a lot of property thrown on the market.

Risk assessors seem to be drawing their danger line for low equity between 15% in slow markets and 40% in hot ones. This is not a good sign. However, multiply the above story a million times, and you can see that there are significant price pressures in RE in many markets nationwide.

Thanks for the kind words.

Robert, you're a good psychologist and you handed out some excellent free advice. It's a pity she didn't take it. So my regards and respect to you.
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