With all the talk of indoor transmission being more likely (than outdoor), we’re moving martial arts outside whenever possible.
I’m going to chat you through the financials of a rental property I used to own in Tucson.
This will help you understand the situation facing airbnb hosts and other owners of assets with high holding costs.
- Picture a condo, bought and furnished for $75,000.
- The condo has a current value of $100,000.
- The condo doesn’t have a loan against it but costs $8,500 per annum to hold (8.5% of value). The high cost to hold is due it being a fully furnished rental => things like taxes, HOA, cable, insurance, utilities…
- The furnished rental does great and yields net cash flow of $4,500 per annum after all expenses, taxes and commissions => 6% of cost.
This was a good investment but I sold out, and switched into Boulder real estate, with a mortgage. Here’s what I switched into:
- Cost to hold the house (mortgage, taxes, insurance and maintenance) => 3% per annum vs 8.5% for the condo. Without the mortgage, the cost to hold the house drops to 1.25%.
- Worth emphasizing the debt-free annual cost to hold comparison => condo 8.5% vs house 1.25%
- House has rights to land, condo doesn’t include any land rights.
- House has alternative uses… can live in it for the cost to hold, or rent and receive a net yield of 1.5% (2.75% excluding the mortgage).
Both locations worked out.
I checked on the condos yesterday and they were selling at ~$150,000 pre-virus, up significantly from 2008-2010 crisis values. Boulder housing has seen similar appreciation.
What concerned me in 2012, when I sold, was the high cost of ownership, which can bite in a downturn.
Picture the condo debt financed => this is the issue facing aggressive airbnb hosts
- A $75,000 purchase, with a mortgage of $65,000 against the property
- To buy the place, you needed $10,000 of equity, which appreciates to $35,000 as the capital value rises (on paper) to $100,000.
- The paper profit is 3.5x your money (yay) => you get this from 33% market appreciation, similar to what has been seen in many markets over the last 3-5 years.
- But… the Virus pops up and the property is going to cost you $7,500 of new cash to hold for the 1st year of the crisis => 7,500 / 35,000 is a negative 21% return on equity.
All of a sudden, the warm feeling of paper profits is replaced by the reality of writing checks, monthly, for a vacant rental.
Depending on your tax bracket, one year cost to hold might be the equivalent of the last three years profits.
The high cost to hold can bite in different situations.
Club Memberships => $50,000 to $250,000 membership initiation fees with annual dues of $5,000 to $25,000.
You can find yourself in a contractual relationship where you are required to pay 5-20% of membership value in a downturn.
Now picture a club with 10-20% of the membership unemployed, or ill with COVID.
In a world with: (a) very low discount rates; and (b) professional compensation under pressure, the “penalty” for paying through a downturn/crisis is accentuated.
Many asset owners are likely telling themselves they are simply facing “one bad season” and things will get back to normal soon.