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Property Investment in Austin: Focus less on cash flow, it’s all in the land


Cash Flow versus Appreciation

Austin has historically been a city that has had incredible appreciation, specifically land appreciation.

From an accounting perspective, a structure is depreciated over a 27.5-year timeline. Effectively, financially, the structure approaches zero well before it’s 40 years old. 

This is why, in older parts of the city, you may have two 100-year-old homes next door to one another. House 1 is 1000 ft.², and house 2 is 1500 ft.². 

Is the value of House 2 50% more than House 1? No.


Why?

Because more of the value is in the land.

This is why betting on appreciation as an investor is very different than getting cash flow as an investor. 

In the center of the city, where the appreciation has been the highest and the market expects it to continue to be the highest, it is not possible to purchase a cash-flow-neutral rental home.  

This may be slightly more likely with a multifamily property, but even then. The structure is likely sitting on such an expensive piece of land that the rents are not likely to be adequate to be cash flow positive. A four-plex on Enfield Rd is likely $1,800,000 sitting on a piece of land worth $1,000,000. The rents may assist in covering the value of the structure but are not likely high enough to also assist with the payment of the land value. The market is telling us that this is no longer the highest and best use for this land and the economics encourage tear down, regardless of the condition of the structure. This is what I like to term an economic teardown.

I’ve always been a big believer in the fact that the market is giving you information. I’ve learned this from many years in trading. If the market is giving you fantastic cash flow, the market probably doesn’t think that you’re going to get great appreciation. Markets tend to find their level and the IRR calculated from the cash flow property is likely very similar to the IRR of the appreciation play.

With regard to single-family homes or small-family duplexes and triplexes the general thoughts below apply.

I have been purchasing rental property in Austin since 2000, and I have never been cash flow positive the first year that I bought property. There were opportunities to purchase cash flow positive properties, however I tend to like vintage homes in the older parts of the city and I buy what I like, thinking others will likely feel the same way.  

I have loaded my portfolio into a spreadsheet and analyzed my return over the years. It has worked out to be about 16% return, but it’s been almost exclusively in appreciation. 

Rental properties eventually cash flow modestly, but due to the higher property taxes from the increasing land value, that cash flow never amounts to much 

Not all cities appreciate the way Austin does, and yes, the last 15 years were unique moments in Austin's real estate history, so no one should plan on that level of appreciation in the future. However, due to the 4 X 1 leverage in a real estate investment purchase, even a modest appreciation of 3% annually can generate a 12% return on investment



For example, if you purchase a $400,000 property and get a 3% appreciation, you “make” $12,000 in paper profits. $12,000 represents a 12% return on the initial investment of $100,000. So, in this situation, even if you have a negative 5% cash flow when you purchase (an annual loss of $5,000) you would still net up to $7,000.  $12,000 - $5,000 = $7,000.

I’ve noticed in Austin that there is very little cash-flow-positive inventory. Therefore, I assume the market is telling us that there will be appreciation in the future, rightly or wrongly. We do know how to find the best cash-flowing properties and have tools to help our fellow agents and our clients find the best opportunities in the market. We’ve built models and algorithms to assist in this time-consuming exercise!




Let us know if you have any questions – we love to nerd out on this!


Cheers!


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