Where Would I Invest A Million Dollars?

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Somebody asked me that.

Well, I'd want to set some aside for liquidity and reserves, in case something happened where I needed money now. invest those funds in a diversified mutual fund and money market portfolio. Once that's done, I'd buy some rental properties, because when government inflicted economic sabotage shakes out, anything I buy now is going to be a lot more valuable in real terms. Leverage the money right, and we're talking at least two to one return, probably more like four to six.

Specifically, Condominiums, and Townhomes. High density housing.

Why? Well for an illustration as to the first part of that reason, look at my article Economics of Home Ownership in High Density Areas. We're in a phase here in southern California where we're getting ready to switch, by economic necessity, away from the single family detached property on its own lot and towards the community interest lot. Land is just too expensive. The average person or family, making an average paycheck, can no longer afford single family detached housing within commuting distance of work unless they've got one heck of a down payment. The demand is too high, and the supply too limited, for everyone who wants one to have one. When that sort of situation happens, price goes up until enough people get priced out.

Here's the trip: When you're talking rent, half million dollar single family detached housing rents for maybe $1800 per month. But if you buy a $200,000 condo, it rents for $1000 to $1200. Put 20% down, and it's very possible to have a positive cash flow on such a unit - something it's not currently possible to have with the detached house. The fact that the spread is so small is temporary, of course, but in the meantime it's an opportunity for a sort of arbitrage.

Furthermore, the average family can afford a fairly nice condominium or townhome. It's just that during the Era of Make Believe Loans, people were told they didn't have to "settle." So they purchased properties far beyond their real means, because they were being told they could qualify for those ridiculously high dollar value loans.

(I call it the Era of Make Believe Loans because the agent made believe people could afford more expensive properties, the lender made believe that people could qualify, and the consumers made believe that there weren't deadly traps they were falling into on every single one of them. It was seductively easy for everyone. The agent didn't have to sell only the property the client could afford, or "settle" for the smaller commission. The lender and loan originators could make money hand over fist on paper. The consumers could pretend they could afford a property far beyond their means, and didn't have to "settle" for what they could really afford. And people are still making believe that the Era of Make Believe Loans is going to come back.)

But denial has a definite half life when it encounters pervasive economic reality. Once it's become accepted that the housing market has stabilized from its free fall, people will be forced to look reality straight in the eye. We had the bubble, we had the pop, and now it's time to start going up again. Once it starts happening, families will be forced to confront the fact that they can't get the American Dream all in one easy step by essentially clicking their heels together and declaiming, "There's no place like Oz!" They will have three options: Stay a renter forever, move away to somewhere there is less demand or more supply, or settle for what they can afford, leveraging it to something better. When larger number of people realize that those are their choices, the demand for and price of condominiums is going to shoot up.

So, put $40,000 or $50,000 into a $200,000 condo, rent it for $1200 per month, and your cash flow is just about even. That's the second half; the situation right now, as it exists. I've predicted rents are heading up in the near future several times. Rent goes up, I'm making a couple hundred dollars per month while values are climbing. In a few years, I've a property that has doubled in value while making me some small cash in the meantime. Multiply this by a dozen, and I've got two to three million dollars from an investment of six hundred thousand or so. Plus, of course, I'm going to pull all the old flipper's tricks just before I sell them. Yes, there's risk - risk that can be minimized and dealt with. That's why I wouldn't be sinking every last penny I had into it, a mistake way too many people have made in the last few years.

Right now, the market in Southern California is very highly segmented, meaning that prices and demand for some things (Single family residences in desirable parts of town) is through the roof while there's a glut of other things (condos). Condos are, for most people, what my econ professors used to call substitute goods for single family detached housing. But when people figure out that it's condos or rent or leave the city where they really want to live, they'll start going for the condos. The hassle of HOAs is nothing near as bad as having a landlord.

Of course, nobody's giving me a million dollars. But if you have $50,000 sitting around, you can make about 10% per year in the stock market with a reasonable amount of risk, Over ten years, that's turning your money into about $138,000. Or, if California real estate increases at an average rate of 5% per year for the next ten years (our forty year average is about 7%), that $200,000 condo turns into a $325,000 condo, while your loan has been paid down to $125,000 and you walk away with $200,000, not counting the cash in your pocket between now and then. If we should actually tie our long term average of 7% annualized increases, that's a $390,000 condo and you walk away with $265,000. Meanwhile, the cash flow picture gets better every year as rents increase. Your choice, of course, but I'm not the only one who sees an opportunity here.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on January 29, 2014 7:00 AM.

Do Furnishings Convey With The Property? was the previous entry in this blog.

When Selling, You Need To Understand Your Target Market is the next entry in this blog.

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