Why I Made an Offer for a Property in Austin, TX

With the Fed slashing interest rate to 0-0.25% in March 2020 due to the response to the CoronaVirus (COVID-19), the real estate market became more attractive. The fed funds rate is the rate at which commercial banks borrow and lend money to each other. This rate is typically set by the federal open market committee (FOMC). The Fed Funds Rate has seen a decline from 2.5% to 0.25% YOY with recent talks on negative rates in the near future. This is a 225 basis point drop and represents a 90% drop in the fed funds rate YOY. The Fed has downplayed the implementation of negative rates, citing that the central bank was not even contemplating the issue. Even without negative rates, owning a mortgage has become very attractive and can boost the returns for investment properties when leverage is used properly. I have highlighted the benefits of real estate in a previous blog post. In this blog post, I will explain the rationale behind my single family real estate offer in Austin and current the investment landscape.

Austin Skyline. Source: Aquilar


The Economy
The US economy has seen its GDP contract by 7% compared to 4Q2019. The decline in GDP was due to the government's response to the COVID-19 pandemic. The government essentially shut down all businesses and schools by issuing "stay-at-home" orders. As demand decreased, most businesses saw a substantial decline in revenue. The GDP value of the United States accounts for 15-20% of the world economy. Other countries implemented a similar "stay-at-home" order. With the collective drop in revenues, some economists are classifying the impact as a global economic depression. The Fed did undertake a $2.4 trillion stimulus package which has kept things afloat during the pandemic. Some have said the package over-stimulated the economy while some have argued that another stimulus package is needed to help fully support the economy. It is difficult to decipher the true impact till the pandemic is solved and a sense of normalcy arrives.



The Stock Market's Current Levels
With the negative impact on revenues realized by various companies, the stock market has endured quite a bit of volatility over the past 3 months. Airline, oil, and hotel companies have been particularly hit hard due to the decreased demand while companies such as home workouts, cloud infrastructure, and food manufacturers have had to keep up with the increased demand as consumers increasingly rely on the internet to work, learn, shop, play, and entertain themselves. The S&P500 reached its low March 23rd and has recovered half of its losses so far. The Nasdaq, however, has recovered all of its losses YTD since the importance of technology is manifesting itself in our daily lives more than ever. I personally have been buying into the market throughout the entire period and continue to buy till all is said and done. Technology companies such as Microsoft and Apple have proved to be resilient and they remain my largest positions by a mile. I initiated a large new position in Tesla once the market dropped and was fortunate to have seen it rise in value. I also added to my position in Bilibili (a video game publisher based in China). To my surprise, Sony also secured a 5% stake in the company for $400 million. Even with the decline in the stock market in the first half of the year, the S&P500 is trading above its average historical price-to-earnings ratio of 17 when dating back from 1927. Although, this ratio is much lower than the PE ratio during the great recession of 2009 where the S&P traded at 123. I still believe there is tremendous upside in the stock market as a whole but it would be prudent to be cautious on what particular companies are added to a portfolio as some companies and industries might be permanently impacted by the current pandemic when it is all said and done. With the market trading above its historical average, I believe alternative investments particularly single or multi-family homes within a growing market would serve as a good hedge especially since people will always need a place to sleep and the need for more space might be attractive to some. The government's stimulus program should also keep the economy afloat till businesses are back running smoothly.

Price-to Earnings Ratio (Historical)


The Opportunity
The four benefits real estate provides are a steady income, appreciation, the ability to use leverage, and tax benefits through depreciation. With that in mind, I have been searching for a single family property to purchase since March as I was confident my credit score would get me a good enough rate to make a decent return in a hot rental market. Plug in Austin, Texas. Austin is the top rated city for real estate investment in 2020 according to a report by the Urban Land Institute. 

                                               

The reason for the increased migration into Austin has primarily been driven by the Technology sector which has in turn created white-collar jobs and lowered the unemployment rate in the area. Not only has employment increased, Austin has also seen a better than average increase in its median income. Texas, in general, has attracted more and more companies to do business in because of its tax friendly nature as compared to California and New York. With the impact of CoronaVirus, some companies have even contemplated moving their locations from California to Texas, Florida, or Nevada with one of them being Tesla. Austin is unique in the sense that it has the talent in place since the University of Texas (a renowned Engineering university) is located in the state's capital. It also has attractions such as the annual Austin City Limits (ACL) music festival slated for October 2020 and south by southwest (SXSW) music festival which tends to attract a lot of millennials to the area. With 51% of the US population being Millenials and Gen-Z, there is an increased appeal for progressive cities such as Austin. With this thesis in mind and location being the most important factor in real estate, I thought it was prudent to investigate the possibility of making a single family purchase in Austin after my initial limited partner (LP) investment in a multi-family apartment on South Congress Avenue in Austin. Fortunately, after a tedious search for the right price and property, I was able to locate a property with the help of a realtor just 6 miles south east of my initial multi-family investment. Within two days of the property coming on the market, the seller received multiple offers. This speaks to the competitive nature of the market in Austin but also speaks to the price point of the property relative to the other homes within the same zip code. The property is close to a state park, a soccer complex, and multiple other parks. More importantly, I was able to raise the down-payment by selling some municipal bonds realizing a 7% IRR tax-free from that sale due to appetite for bonds over stocks during a downturn. I will touch more on the bond sale below. 

Source: knoema


The Sale
In order to come up with a down-payment, I decided to liquidate the municipal bonds I purchased a year ago. Municipal bonds are the only types of bonds I typically purchase and I was able to achieve a 6.94% IRR after the sale. The reason I only purchase newly issued Muni Bonds are the ability to purchase it at no cost, its relative risk, good returns and tax-free nature. Muni Bonds typically generate 5-6.5% in stable income when accounting for the impact of taxation. Taxes can eat into the returns we realize from different investment vehicles. Long term capital gains tax rate is around 15% and short term capital gains are taxed at the ordinary income tax bracket which can vary from 10-37% depending on annual income. The interest earned from Muni Bonds are exempt from taxes boosting the net returns achieved. Half of the Muni bonds were purchased below par. This is an important aspect to note when purchasing bonds. The face (or par) value of a bond in the US is typically $1,000 and depending on supply/demand, a bond can be sold at a discount or premium which impacts the yield to maturity. The yield to maturity will be lower than the coupon rate if the Bond is bought at a premium and vice-versa if bought at a discount. It is typically better to purchase at a discount so you can achieve a higher return than the coupon rate. Bonds can also be called by the issuer before it matures so it is very important to focus on the yield to worst as that will be the minimum yield you will realize. It is better to exclusively focus on the yield to worst when compared to the bond’s coupon rate or yield to maturity.



Pre-approval and Offer Letter Process
A day after the property came on the market, I went through a tour. I also had to get a pre-approval letter on a weekend in order to submit an offer as they were due Monday. Due to the slash in interest rate, being in a good financial shape, and an excellent credit report, I was able to get pre-approved quickly. Based on the under-writing, my plan is to carry a 80% loan-to-cost (LTC), 30-year fixed loan. The 30-year loan would be in the high 2's interest rate and offers the flexibility of a lower mortgage payment. With this rate, I am projecting the property to cash-flow in its first year. The realized IRR when it is all said and done is to be seen but given a conservative growth rate assumption, I anticipate the annualized rate of return (IRR) to be in the high teens. With a more aggressive growth rate and an aggressive rental marketing strategy, the property could surpass a 30% IRR if sold in 5 years. After I got the pre-approval letter, my realtor drafted up an offer letter and sent it over to be signed. Once fully read and signed, she was able to submit the letter a day after the initial home was put on the market. Since my offer has not been accepted yet, the mortgage process is still in flux so there would be changes. Overall, I have been pleased with the bank and realtor as they have all acted very quickly (within the span of 2 days). 

To end on a high note, due to the recent drop in interest rate - it might be beneficial to refinance your mortgage or keep abreast of any opportunities to deploy capital in a currently uncertain world. It is, however, important to assess your financial situation first before making any moves. I personally use Personal Capital to track my spending and get a quick, dynamic view on my financial strength.

Source: Personal Capital



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