Buying Investment Property in California – High Prices, High Rents
California real estate runs the gamut from affordable starter homes to mid-range ranches to luxury estates and beyond. For investors, California provides ample opportunity to tap into some of the state’s best rental markets – that is, if you have the right financing.
If you’re interested in possibly purchasing investment real estate in California, you’ll likely have a lot of options to choose from. From San Diego to Redding and everywhere in between, there are numerous properties for sale. But before you go jumping into the investment real estate world, you’ll want to know a thing or two about the rental market in your area, not to mention the financing options that are available.
California Real Estate Market
Because California is such a large and diverse state, it’s difficult to say whether it’s a “good” idea to invest in rental property. Naturally, the value of the investment will also be affected by the borrower and their financial situation. Also, the markets can change from month to month, season to season and year to year. Nevertheless, we can provide a basic overview of the current real estate market in different parts of California to help you make a more informed decision. Take a look at some of the markets below:
San Francisco & San Jose
Known for having some of the highest rent prices in the world, San Francisco may actually start to see a dip in rents. According to a recent article from The Mercury News, a new study found that monthly rents dropped markedly from August to September in San Francisco and San Jose. The study, conducted by apartment search website Adobo, placed both cities on its Top 10 list for the “Biggest Fall” in rents for one-bedroom apartments during that period. Still, the reported drop in rent hasn’t exactly made San Francisco a cheap place to live. Even with a 6 percent decline — the second-largest decrease among U.S. cities — San Francisco’s average rent is still well over $3,000/month. San Jose had the largest drop at 12 percent, moving the average rent to $2,455.
With median home prices for San Francisco and San Jose at $1,104,000 and $822,700, respectively, it would seem neither market offers much return on investment for landlords. Using the median home price figures above, and presuming the buyer chose a 30-year fixed rate program with 20% down, median monthly mortgage payments for San Francisco and San Jose would be $4,004 and $2,983, respectively – both of which are higher than the monthly rent and do not include additional costs for taxes and insurance. So, by our very general calculations, San Francisco and San Jose may not be prime territory for landlords looking to make a profit each month.
The average rent in Fresno is reportedly at $924/month, according to RentJungle.com, a site that compiles rental data across the country. This is significantly lower than rents in the larger cities mentioned above. But does that necessarily mean Fresno is a better market for landlords? According to Zillow, the median home price for Fresno, CA is $197,100. Presuming you made a 20% down payment on a 30-year fixed rate program, your monthly mortgage payment (including taxes and insurance) would be $963. That works out to $39 less per month than the average rent. Keep in mind however, these figures simply represent the average rent and median home price for Fresno. If one were to find a home priced below the median and could charge an above-average rent, then the possibility of making money off the property each month is greater. For instance, say you bought a home in Fresno for $25,000 less than the median sale price, keeping the down payment and loan terms as before. That would give you a monthly mortgage payment of around $849 with taxes and insurance. And let’s say you charged $975/month to rent the home. That would give you $126 more per month. So, by our general calculations, Fresno may be a good market for landlords, although the return may not be very high in the short term.
Consider Long Term Investment
The markets above may not show ideal short term profit for California landlords, but keep in mind real estate values are on the rise across the country. Property owners who can rent out their homes instead of selling them may find the increase in equity could pay off tremendously in the long run. There are some financial experts that believe getting into investment real estate should be for the long term anyway, and short term profit is actually a rarity – typically only abundant when there is substantially higher demand for rental housing and home prices are stagnant. We’ve see those conditions in a lot of the U.S. during the past several years; however, things appear to be changing. In California’s largest cities, renting may actually be cheaper than owning. By contrast, smaller communities may still offer a better deal for owners, opening up opportunity for investors. Then there are the California cities somewhere in between, where rent is just slightly higher than the cost of a mortgage but may not provide enough of a short term return to make it worth your while.
Investment Property Financing
If you’re in the market for investment properties, you’ll need to get pre-approved for an investment property loan from a reputable California lender. Investment property financing allows the borrower to purchase a home that will not be used as the homeowner’s primary residence, but rather will be used as a rental property. When applying for an investment property loan, the lender will likely take the following things into account:
- Your debt to income (DTI) ratio
- Your credit score
- The loan to value (LTV) ratio (your down payment)
- Any other debts you may have
- Anticipated rental income from the property
Exact underwriting guidelines may vary. Talk to a mortgage professional for details.
Is Buying Rental Property for Me?
To determine if buying rental properties is a wise financial choice, first examine what you hope to accomplish. Are you in it for the short term to increase your monthly cashflow? Or are you looking for something long term, to diversify your wealth and possibly supplement your retirement when the time comes? After you decide what you’re going for, talk to a financial advisor and a qualified, experienced mortgage loan professional.