Investing the Regular Way
by Jim Scott

Last month in this space I discussed the economics of purchasing smaller rental properties and single units for investment purposes. The article concluded that timing was perhaps the most important facet of a successful investment in this type of property. This month I will examine traditional investments.

If you time the market right, there is no way to beat the net returns on single units—the appreciation and leverage factors far outweigh the effects of negative cash flows. Larger investment properties should be structured to weather recession-driven storms and are not as dependent upon appreciation cycles for their success. The goal is to have immediate positive cash flow that will increase over the rate of inflation. Appreciation, more modest than houses, follows the ordinary and expected net income gains over time.
But there is a twist; San Diego apartment buyers have adopted a house condominium mentality and no one seems to care about negative cash flow.

 The Apartment World... San Diego Style
San Diego apartments have had a near record run of increasing prices beginning in 1997. But this is not new. In 1975 you could buy apartments for $10,000 per unit and then sold in 1979 for $40,000. Inflation in the general economy sparked that particular up-cycle. The market we are now experiencing is being driven by the lackluster stock market and by the condominium conversion market. In either scenario, prices have risen too high too fast, setting the table for the inevitable price correction. Like houses, apartments with good locations come with their own lifeboat. As long as you can maintain the investment, inflation will always make any real estate a winner given enough time. My 31 years of apartment-investing experience have shown me that San Diego apartments have operated in their own unique world freed from the ordinary rules of investing. This is not the first market I have witnessed where investors gladly pony up and accept negative cash flow. Unless you are sure you can convert to condominiums or you have other specific needs, purchasing units today seems a bit risky for my taste.

So What to Do?
In response to the maturity of this market cycle, I have been taking some San Diego chips off of the table and moving them into other products and markets. I have been buying positive cash flow investments that still have decent appreciation potential. Our investment group has focused on mobile home parks and self-storage projects. Both offer immediate and lucrative positive cash flows. Both products offer substantial protection against recession. But keep in mind what I noted above; if you get the timing right you cannot beat the overall returns in single-family homes. Of course, I could have unloaded all of my Qualcomm at $210.

My most recent transaction in progress involves a tax-deferred exchange from an 18-unit North County apartment building to an older 78,000 square foot self-storage project in Las Vegas . My partners and I acknowledge that we are assuming greater appreciation risk in return for two things; first, we have sold our building with deferred capital gains taxes at probably the peak of the market in San Diego and second, quintupled our positive cash flow. All of us in the group know we will not obtain, over time, as much appreciation as we would get with a well located building in the North County . But if you model the two investments over a 10- or 15-year period, the internal rate of return on invested capital should be greater with the positive cash flow project, unless you are a great market timer.

Our group scours most of the Southwest and West for good projects. We even have a property in escrow in Valencia , Spain . The plan is to convert an old paint factory into the city's first large self-storage project. If the idea works the returns will be spectacular in spite of currency and other inherent risk factors. Our group has concluded that the European market is ready for this product. Consider this; there are 40,000 self-storage properties in America and 500 in Western and Eastern Europe . Why Spain ? Until the stock market rebounds or interest rates increase, our economy is awash in cash seeking yields in good investment real estate. The inevitable result of is a seller's market in investment real estate. Although we have several storage projects in current operation and under construction, the opportunities in Europe provide the potential of higher returns and risk diversification.

The House Market Revisited
Last month in this column I promised my 2005 forecast by Halloween. Since my deadline is the 15th of October, it will show up next month. This has been the most difficult market to call. I think that matters are far better than you might imagine. I have some new approaches to my analysis of the market that suggests everything is really all right.

Read Jim's back articles at www.sqre.com or call him for selected b ack issues, 619 920 9511

I welcome your comments; my email address is jimscott@sqre.com.

You can reach Jim Scott at his office, conveniently located in the heart of Mission Hills, at 1111 Fort Stockton Drive. Founded in 1982, Scott & Quinn is the oldest full service real estate firm in Mission Hills and is still locally owned and operated. Jim has been a homeowner in Mission Hills since 1976. He is married and has two boys. He can be reached at 296-9511, extension 100. Scott & Quinn features professional property management as well as 15 sales associates. Click here to see Jim's past Market Reports .