Q & A with America’s Real Estate Professor: Low investment yields

Discussion also involves claims on insurance.
Zillow
Oct 2, 2013

Low Investment Yields, Still Invest?

Q. Given the apparent frenzy in the under $300K range in San Diego, any adjustments you recommend to your rent/buy/invest evaluation process related to just focusing on cash flows, since the cash on cash returns are so low? I think I’ve got to now look more toward appreciation in value than cash flows. Would/are you buying these low yields? Bart B. San Diego

A. It’s great that at least you understand that cash flows are one of the most important measures for evaluating a real estate investment. Most people have no idea what that means, and I’ll explain that in more detail. As you noted, the yields are pretty slim, which is too bad, but the market is the market. The last couple of properties I purchased last year had pretty low yields, but I bought nice quality, moderately priced, lower risk properties. I wish the yields were better, but I’m a long-term holder, and 20 years from now when the cash flows are flowing; what I paid today and the yield won’t be a concern.

If you are a long-term holder, and you shouldn’t buy real estate if you are not, then I’d charge ahead with buying as long as they are positive with a few percentage points of yield, and lower risk properties that are for example, in good shape, in moderately priced areas, HOA’s decent condition and without title issues. If the yields are too low (and only you can make that call) it might make sense to skip real estate for a while.

Hopefully with some cash flow, appreciation, mortgage principal pay down and some tax savings, you’ll have an overall nice long-term return on your money.

For newer investors, Cash on Cash Return = Free Cash Flow / Equity Invested

Properties will return a COC yield, probably between –8 percent and +5 percent. Go for the positive if you are an investor.

Claims on Insurance

Q. Several years ago I made many smaller insurance claims on my policies – which looking back now I am learning was a mistake. Apparently the insurance companies have record of claims and don’t like customers like me. So now I’m getting rejected and/or pretty high quotes on policies. Any thoughts? Robin H., New York

A. Sorry to hear about this. But yes, insurance companies do not like people who make lots of claims. It probably costs the insurance company several thousand dollars to process a claim, even if the claim is only for $400. So most companies share in a database of policy claims, so they can avoid people who are excessive claimers! This is called the Comprehensive Loss and Underwriting Exchange.

Most insurance carriers will review your overall history and price your policy based on your past behavior. So beware to all individuals – do not make claims on your insurance policies unless it’s a real issue and a fair amount of money! Otherwise, you’ll pay more down the road for coverage or be denied, like Robin.

This is also a reason to procure and review a CLUE report on any property you are going to buy, because a property with a bad CLUE history could be denied coverage even if your history is perfect.
 

Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions. He is a San Diego State University lecturer, blogs at Zillow, and loves kicking the tires of a good piece of dirt! More at ProfessorBaron.com. Email your questions to: Leonard@ProfessorBaron.com