Thursday, September 6, 2007

Lets go through this one more time...

Repetition is the mother of learning, so lets take the "overvalued property makes poor investments" lesson one more time. Our learning objective can be summarized in three simple points:

1. At current valuations, it is not possible to make money from renting property out.
2. The only way to make money is through capital appreciation.
3. If interest rates are expected to rise, property prices will fall.

To illustrate these points, lets take an example of a property from a city that hasn't seen a massive price bubble - Chicago. The property above is located in Lake View, IL and it is currently on the market for $1,279,000. At a 6 percent interest rate, the financing costs are $7,600 per month. Taxes are currently $6,000 per year and likely to go up to $10,000. However, the property has two tenants, giving a combined income of $2,500 per month, with a contract that continues until April next year.

The first point of our lesson is self-evident. A new owner who buys this property will lose at least $5,000 per month if he rents it out. However, can he make money out of the property through capital appreciation? Well, it is very doubtful indeed. The property has been on the market for 84 days, and the owner has already reduced the price from $1,295,000.

We now move to point 3 - future interest rate movements. The Fed has already hiked them 15 times, and most informed commentators expect at least two more hikes. Higher rates mean higher financing costs, lower demand and ultimately lower house prices.

Only a fool would buy this property.

Here ends the lesson. Remember it. Revise it regularly, and if you are tempted to buy, repeat the lesson. Finally, let me set the end-of-term exam and supply a crib sheet.

Question - In a climate of higher expected interest rates, should you buy a property if rental income does not cover the mortgage and financing costs?
Answer - No!

Take the test every time you see a rental property on the market.

Thanks to Ferromancer for this listing. If you would like to provide some additional exam revision, please send overvalued, profitless rental opportunities here.

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