In May 2008, I wrote up an article about my search for an investment property – makes interesting reading about the state of the market, as I saw it, back then.

My criteria in mid-2008 (just before we hit-the-wall) were:

• Climate opposite to Boulder, CO
• Would enjoy using during vacant periods
• Less than 1% annual holding costs
• Forecast net yield (after all expenses) 10% over treasuries
• 50% capital upside over a ten-year view
• Entry price less than $200 per sq foot
• Superior location in a prime destination
• No leverage purchase — don’t reach financially

To a property guy, “prime Arizona” is Scottsdale not Tucson but… “prime” for me means prime cycling and friends!  If that means I trade a little capital appreciation, then I’m OK with that.

Given that I’ve been explaining the Tucson property market to my pals, I thought that I’d run through the case study for you.  When all the smart money says that a market is going to fall 20%, it’s a good time to consider buying.

I’ve been looking at Tucson for three years, mainly to address my goal of winter cycling fitness.  While I’ve had great success with seasonal migration to Australia/New Zealand, it is a very expensive option for my family.  So I’ve been looking to change my winter cycling “cost” into property investment “income”.

Because of my personal, and corporate, position, my downside is a lower cost location to ride with my pals.  This is where my business (Endurance Corner) enables me to protect my downside scenario.  I know other people that do similar things – by locating their company’s office inside a commercial property deal.  You can often create strategic benefits to your investment life, from your working life.

I had considered buying a house in Tucson (still would like to) but the holding costs are too high and they are far tougher to manage for investment income.  I even know the exact house but can’t bring myself to increase my personal overheads.

When adding up your uses of cash be sure to include:

• Purchase Price
• Transfer Fees
• Taxes – I pre-fund the first year in my mind
• Insurance – if you pay HOA then the external building is probably covered, but you’ll need coverage for the inside and your fixtures/fittings/furniture
• HOA Terms – most places have restrictions on property use, read these as they can bite you in the bum – similar to taxes, I pre-fund a year’s worth of taxes in my calculations.  Make sure the seller is picking up HOA and tax arrears on the property.
• Furniture – depending on taste, you’re looking at $5-20 for a reasonable specification.  My advice is “under buy” on furniture for a rental property.  It will get trashed and it’s worth NOTHING if you have to sell it.  If you buy more than one condo (for investment) then consider leaving one unfurnished so you have a fall back in case you need to unload one of your units.
• Repairs – I’ve been looking at foreclosed properties.  Often these have damages and require extensive repairs.  Estimate the cost to repair, double your estimate and subtract that from your bid price.  Also, double the time that you expect the repairs to take.  Budget your holding costs (HOA, taxes, utilities) for the extended repair period.
• Closing Costs – about $1,500 for a standard completion, seek to split these with the vendor.

Taking all of the above into account, Tucson is currently selling for ~$70-90 per sq ft (furnished).  That’s cheap.

It’s cheap for a reason, there are relentless foreclosures because mortgages are oustanding at $150 per sq ft.  While the foreclosures work through the market, there will be no capital appreciation and it will be near impossible for a non-bank owner to achieve a decent price.  

When estimating your prospective return remember to include:

• Water – often covered by your HOA, which surprises me in a desert.
• Telephone / Cable – if you go for direct TV make sure you can mount the dish with a southern aspect and your HOA allows dishes.  Have the Direct TV guy wire the dish into your cable system (already wired in your condo probably).
• Electricity – if disconnected allow for getting a city permit to reconnect.
• Appliances – if missing then make sure your dryer door will open when installed – we had a little snafu with on of our purchases.
• Vacancy rates – take whatever vacancy rate you think you can achieve and increase it by 25% — still OK with the deal?  Also, how are you going to rent the property off-peak?
• Own use periods – Southwest has $49 one-way flights to Tucson from Denver.  Sounds cheap, but… $50 bike fee each way and $70 per week parking fee (for my car at the airport).  So it’s a minimum of $270 per trip for me to head down.  Closer to $500 with taxes and a car rental.

Other issues:

1. Make sure you’re clear with the agent about your intended use – some foreclosed properties are sold on the condition that it is our main residence.
2. To get the best pricing, you’ll want to offer a cash deal, quick completion and buy on a “as is” basis.  
3. It is very tough to raise debt finance for investment property but it won’t be that way forever.  While I wouldn’t count on it, I suspect that money to refinance will be available down the road, after you have a three to five year track record of rental income.  Within my own projections, I can see a scenarion 
4. What can go wrong – consider your exposure to long vacancy periods, fire, theft, furniture damage, and aircon bills.  You will get hit with all of these eventually.
5. Banks are under pressure to unload foreclosed properties and bankers are handling a huge number of transactions.  Therefore, it makes sense to increase your margin of safety with your bids.  As we move out of peak season, the banks know that they will be looking at HOA, taxes and maintenance for the entire low season.  Mid-summer could be an excellent time to pick up SunBelt real estate at highly attractive prices.

Remember that property is “easy in” but “difficult out.”  Make sure you are able to hold for at least five years.  It could be a rough ride but it looks like a good bet to me.

Tweet me any follow up questions and I’ll try to cover.