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.

Perhaps.