Investing in Declining Markets

Declining markets can appear very attractive to investors: low prices with good returns. In this article we look at the long-term consequences of investing in such markets.

The Attraction of Declining Markets

In a recent blog post I read an investor told of how she purchased a 3-bedroom home for $50,000, spent $10,000 in rehab and was renting it for $650/Mo. Based on my email with her I put together the following guess.

Amount/Rate
Purchase Price $50,000
Rent (Mo.) $650
Interest rate 5.5%
Down Payment % 20%
Down Payment $10,000
Loan Term (Ys.) 30
Closing Cost % 4.5%
Debt Service (Mo.) $227
Property Tax % 2.5%
State Income Tax % 4%
Management Fee % 8%
Rehab Cost $10,000
Insurance (Yr.) $800
Debt Service (Mo.) $227

Calculation ROI:

ROI = ((Rent - Debt Service - Management Fee - Insurance - Real Estate Tax - Periodic Fees) x (1 - State Income Tax))/(Down Payment + Closing Costs + Estimated Rehab Cost)

ROI = (($650 x 12 - 227 x 12 - .08 x 650 x 12 - 800 - .025 50000 - 0) x (1 - .04))/(10000 + 50000 .045 + 10000)

ROI = 10.4%

Based on ROI alone this appears to be an outstanding property!

However, when researching the location in which the property is located I found the following: Population Change since 2000: -4.3% Per capita non-inflation adjusted income change between 2000 and 2012: -4%. If you take inflation into account, the actual loss of buying power is closer to 5.2% Sales prices of properties have fallen: $/SqFt: 2006: $80/SqFt, 2014: $31/SqFt Non-inflation rental rate 3 year change: -2.47%. If you take inflation into account, the actual loss of buying power is closer to 3.3%. The diagram below illustrates what will likely happen over time to a property in a declining market.

At some point in the future the collected rent will be less than the recurring expenses plus maintenance. It may actually get to the point where it is less expensive for you to leave it vacant than to pay all the costs for the rent you receive. However, the mortgage and property taxes still must be paid. In the long run the investor's options may be defaulting on the debt or continuing to pay the mortgage and property taxes with no income indefinitely.

Summary

Declining markets may appear to be desirable in the short term but in the long run are likely to be a financial disaster.


Want to know more about investing in Las Vegas real estate? Contact us today. You will be glad you did.

Eric Fernwood, Realtor | 702-358-8884 | EricFernwood@gmail.com
Cleo Li, Realtor | 512-296-0425 | CleoYLi@gmail.com

Vegas International Properties Group (VIP Realty Group)
7570 Norman Rockwell, Suite 140
Las Vegas NV 89143