In his October, 2015, article Investing versus Flipping, Chris Brightman of Research Affiliates, Inc. compares the economics of rental property investments in Atlanta, Georgia, versus flipping homes in Orange County, California.
Relative Value of Houses
Let’s compare the housing market here, where we live in the OC [Orange County], to Atlanta. The best bargain we can find in the OC is a three-bedroom, two-bath house that sells for $500,000. Yep, for those of you unaccustomed to California real estate prices, the cheapest houses in OC fetch half a million dollars. We could rent one of these houses for $2,000 a month.
As shown in Table 1, the prices in the OC are—to anyone who doesn’t live here—insane. If we were to invest in a house today as a rental property in the OC, our net annual rental yield (annual rent minus taxes, insurance, and property management) would be about 3% before tax. Of course, we can reasonably assume that home prices rise with inflation, so this is a real yield. Not bad. But California and the IRS tax even the inflation portion of the return. This yield is then mostly taxed away, at higher rates than in Atlanta, to deliver less than 1% real return, after income and capital gains taxes. I don’t like this investment. House prices can go down as well as up. The high prices in the OC seem risky to me.
Instead, we buy houses in Atlanta. Today, we buy renovated “three/two” houses (three bedrooms and two bathrooms, in the parlance of the trade) for $80,000, and then rent them out for $850 a month. As shown in Table 1, our net pre-tax rental yield is 9%, and approximately 5% after tax. I have strong conviction that buying rental properties in Atlanta at a 5% real after-tax yield is a far more sensible and safer way to accumulate wealth for our retirement than buying rental properties in the OC with an after-tax yield of 1%.
Flip That House?
Now, to some of my house-flipper friends in Newport Beach, the OC seems the better bet. The OC is local, prosperous, and safe. House prices have been rising rapidly for many years; they’ve even recovered the full damage wrought from the 2008 global financial crisis. Atlanta, in contrast, seems far away and scary. They have a point; the urban neighborhoods of Atlanta have a very different socioeconomic profile than Newport Beach and must deal with the corresponding issues of a less educated renter base, a less prosperous population, and a higher crime rate. I can confirm that Donna and I don’t feel quite as safe when wandering the streets of the neighborhoods in Atlanta where we search for houses as we do during evening strolls through our quiet neighborhood in Newport Beach. That’s, in part, why a comparable house costs $500,000 in the OC, but only $80,000 in parts of Atlanta.
When my local house-flipper friends ask how I can be sure that house price appreciation in Atlanta will outpace house price appreciation in the OC over the coming year, I respond that I have no clue about the prospects for short-term price changes. If I had to guess, I would pick the OC as the hotter market. But I am not flipping houses, I explain. I am investing to build long-term wealth.
We can help you buy Rental Property or Flip Houses in any Market: