If you're like me, you think California is best overall state in the country and one of the best places to live in the world. Every region of California offers something different and the state as a whole is an outdoors man's dream. Hiking, vineyards, surfing, cycling, etc is at your disposal....and that's just around Los Angeles. California also boasts world renowned restaurants, state of the art health and fitness studios, the most innovative tech companies in the world and don't forget the happiest place on earth, Disney World!
As diverse as California is, very few people truly get to experience the wonders of the west coast. This is because Californians struggle to retain disposable income. Everything from food and fuel to taxes and real estate costs an arm and a leg here. While we can discuss the hardship of dropping $75 at the gas station to be stuck on 405 traffic, let's share the pain of the current real estate situation in California.
Here are the 3 major problems with California real estate.
1) California is the #2 most expensive state to invest in real estate in the country. Can you guess what holds the #1 spot?....it's Hawaii. Makes sense, right? According to Zillow, the average home price in LA county is $610,000. That's crazy! In most of the country, a $600,000 home would be your "I made it in life!" house; a mansion for sure. Here, that's average.
Adding salt to the wound, California takes a whopping 13.3% state income tax according the Federation of Tax Administrators. Guess what rank that is....#1 highest in the country.
So if you want to invest in property, not only do you have a smaller percent to invest, the average home price is outrageous!
2) California property is costly on your finances and your lifestyle. Good luck affording a conventional loan and enjoying the wonders California offers with these mortgage payments. Let's say you understand the cost but truly believe in the real estate market here. I get it. Again, California is awesome! If you were to buy an average $600,000 home, you would have to put 20% down in a conventional loan. That equates to $120,000! Yes $120,000 is just your down payment. Not closing costs and not including furniture.
Even if you have $120,000 for a down payment, a 30 year mortgage with a 4.07% interest rate would equate to a monthly payment of $3567. Add taxes, insurance, maintenance, and repairs, and you can be spending an extra $10,000 per year. Good bye summer trip to Lake Tahoe.
If that financial burden isn't scary enough, many people have extremely short memories and don't account for the fact that the real estate industry is cyclical.
Just like the stock market and fashion, real estate is on a cycle. Take a look at the graph on the right and guess what stage you think were in?
3. Lastly, California offers the lowest rental returns in the country. Creating a portfolio of rental properties is a proven strategy to creating long term wealth and a lifestyle that combines ample free time and money. Robert Kiyosaki, the author of Rich Dad, Poor Dad, preaches investing in real estate with positive monthly cash flow. (To receive free detailed notes of Rich Dad, Poor Dad, click here and enter your name and email on second form down.) Unfortunately, California offers negative cash flow since rents can't keep up the insane prices of the property itself.
A cap rate (capitalization rate) is a formula that investors use to calculate monthly cash flow. The formula is Net Operating Income divided by Purchase Price. For example, lets say you purchase a property for $500,000. A renter pays $2500 per month or $30,000 per year. After subtracting taxes, insurance, other fixed costs, and a reserve for vacancies and repairs, let's say you're left with $1700 per month or $20,400 per year. You then divide that $20,400 by $500,000 to get .04. Multiply this by 100 to get your cap rate as a percentage....4%.
Unfortunately, 4% would be considered high for LA while that same 4% is atrocious for most markets. A cap rate of 8% is typically what properties offer in Florida, but sometimes even up to 12% or more.
Why is this important? Because if the rent isn't enough to cover your expenses, you will be handing your money over every month instead of adding it to your bank account. Remember, a cap rate doesn't include any mortgage payments. If you are using traditional financing, you will be adding another chunk to that expense column and if the cap rate doesn't equal 8%, most likely you will be in a negative cashflow situation. This is very dangerous because you are not protected when the market stabilizes. With a low cap rate, you are playing the stock market so to speak. You are banking on appreciation to bail you out but if the market doesn't follow your wishes, you will be paying dearly for it.
This is a typical problem in California cities as well as markets like Miami and NYC. In fact San Francisco offers cap rates of 2.7% and LA's average is 3.2%. So in the above example, your mortgage payment would be roughly $2000 on a 30 year mortgage and $3000 on a 15 year mortgage both at 4% interest with $100,000 as a down payment!
Best case scenario, you're only in the hole $300 per month. Worst case scenario, you're in the hole $1500. Imagine making room in your budget for an extra $300-$1500 per month for an investment that is supposed to create wealth and a wonderful lifestyle.
The solution is to invest in properties and areas that are recession proof because they have positive or at least break even cashflow. My mentors always preached to me "A good investment is one that is good in a healthy market, good in a flat market, and good in a down market." This means you chase cashflow while appreciation chases you.
When the market is strong, you will be receiving money in your pocket after expenses every month plus good appreciation.
When the market is flat, you will be receiving money in your pocket every month and perhaps some appreciation.
When the market is depressed, you will be receiving money in your pocket every month regardless if there is any appreciation.
By having your money truly work for you short term and long term, you will be able to build long term wealth with short term cashflow to enhance your lifestyle.
Here are a few articles with the top markets for real estate investing...
Looking to meet fellow investors in the Los Angeles area? Check out the Out of State Real Estate Investors of LA Group on Meetup.com