Quick Start Guide for Colorado Real Estate Investors
This quick start guide outlines what Colorado real estate investors need to know to get started, and when is the perfect time to invest in rental property. It lays the foundation for putting together a long-term strategy.
Colorado Springs Market Trends
There are plenty of investment opportunities in Colorado Springs thanks to its strong economy. Numerous military bases are based in the city (Peterson, Schriever, Fort Carson, plus the Air Force Academy and the Space Force). Rental housing provides military members with an opportunity, as most do not wish to buy if they will only reside here for a few years. Many commercial companies have moved to Colorado Springs over the past few years, especially those involved in the tech sector. Tourism also contributes substantially to the city’s economy. The city’s many parks and trails, such as Pikes Peak and Garden of the Gods, attract visitors from all over. The tourism industry serves both as a source of revenue for the city and its businesses, as well as attracting people to live here.
In comparison over the past several quarters, the basic summary of what is happening: supply is extremely low, and prices are going up.
The number of showings per listing for March and April of 2020 (during the COVID shutdown) is higher than it has been in the past. The average number of showings per listing is over 11, so there is no sign of seasonality. Buyers are all focused on the same few properties that match their criteria.
Per the census, the median household income in Colorado Springs is around $60,000. If we back into the 3x rent rule for qualifying a tenant (the tenant’s monthly gross income must equal three times the cost of monthly rent), this would come to roughly $1,600 per month ($60,000/12 months= $5,000/3=$1,667), so you would capture most of the market share of those looking to rent. In Colorado Springs, it is still a good time to purchase rental properties. Colorado Springs is still a relatively affordable market to buy rental property in comparison to other Colorado metros.
It is important to note, however, that home prices are increasing slightly faster than rent prices. Prices for purchase and rent in Colorado Springs grew faster than the national average.
How does this affect investors? If a house was purchased for $200,000 in 2019, it would be worth $214,000 in 2020, assuming a 7% price increase. The average rent for that same house is only increasing by 4% annually, or what was $1,200 last year is only $1,248 today. Buying a similar house in both 2019 and 2020 would improve the Gross Rent Multiplier (GRM) from 13.8 to 14.2. Projecting this out over five years, the GRM is 15.6. In other words, the deals are still there, but the longer you wait, the more you lose to appreciation.
If you are still interested in investing in Colorado Springs, we have identified different strategies and areas of focus in the next sections.
Single Family Rental Property Investing in Colorado Springs
Single-family rentals (SFRs) are housing that includes condominiums, townhomes, and single-family homes (SFHs). In this section, we will explore the current SFR market in Colorado Springs and what this means for buy-and-hold investors.
Price and Sales Trends
A single family home has a greater price growth year over year than a condo or townhome. Condos and townhomes, however, also appreciated. The median sale price of condos and townhomes increased 14.1% from September 2019 to September 2020. Over the same period, the median sale price of single family homes grew by 18.8%.
Colorado Springs is currently experiencing very strong growth rates for all types of residential real estate, exceeding both historical (5-6%) and national averages (4% per year). SFHs, condos, and townhomes have less than one month of inventory in both categories. In general, this indicates that sales prices will increase for months to come, until inventory levels change in response to the demand.
Rent Trends
Buildings with 9-50 units had the highest vacancy rates at 5.9%. Buildings with 0-8 units had the lowest vacancy rate of 0.0%. The vacancy rate has historically been higher in larger buildings. In Colorado Springs, only 5% of renters were delinquent on their rent payments during COVID (although the actual collection rate is unknown). The rental market in Colorado Springs is strong, however there is not enough supply, which results in a low vacancy rate and high rental prices.
Underwriting Colorado Springs Rental Properties
1% Rule: The 1% Rule states that the monthly rent should be 1% of the purchase price. Colorado Springs doesn’t have many properties that meet this rule. They don’t help you build long-term wealth or great rental properties.
50% Rule: The 50% Rule states that 50% of your rental income will go towards the property operating costs (all the costs except for mortgage payments). As in Denver, Colorado Springs renters typically pay between 25% and 35% toward operating costs. Our underwriting is conservative and realistic.
Multi-Family Rental Property Investing in Colorado Springs
For purposes of this section, multi-family homes consist of properties with two or more units—Duplex (2-unit), 4-plex, and so on.
Price and Sales Trends
Based on Q2 2020 figures, there is a 4.5% vacancy rate for apartments in Colorado Springs. The highest vacancy rate was 5.9% in buildings with 9-50 units. Vacancy rates were lowest among buildings with 0-8 units (0.0%).
Duplexes and fourplexes comprise 90% of the multi-family units sold in Colorado Springs during the past year, so if you’re interested in buying a multi-family, you’re probably going to be looking at duplexes and fourplexes. Multifamily rentals have, on average, slightly better returns than single-family rentals.
Multi-family properties are experiencing the same compression of cap rates as the single-family market. Increasing purchase prices aren’t keeping rent rates up. There has been an increase in the demand for multi-family properties due to the recent decrease in interest rates: in other words, a better return on your (leveraged) investment.
BRRRR Investing in Colorado Springs
Over the past few years, BRRRR opportunities have become more of a rarity, as margins have been decreasing due to increased demand in properties here. This section aims to describe the current state of BRRRR in Colorado Springs.
What is BRRRR?
There are many different strategies to real estate investing, to include buy-and-holds (traditional rental properties), wholesaling/assignments, fix-and-flips, vacation homes including short term rentals, syndication, and more. BRRRR is a repeatable “buy and hold” sub-strategy to acquire rental properties for little to no money down.
BRRRR is an acronym that means:
- Buy—Purchase property in need of repair below the current market value.
- Renovate—Fix up the property to excellent rental condition.
- Rent—Rent out the property for positive cash flow.
- Refinance—Cash-out refinance at a higher appraised value to receive back most, or all, of your initial down payment and renovation costs.
- REPEAT!
Below is an example:
Buy—Purchased for $113,500 (20% down payment of $22,700).
- Loan: $90,800 hard-money loan.
Renovate—Full House Rehab of $25,000 (closing fees, holding costs, repairs).
- All In: $138,500 ($47,700 personal funds).
Rent—Initially Rented at $1200/mo. Currently Rented at $1300/month.
- Initial Positive Cashflow: $300/month (before contingency expenses).
Refinance—Appraised at $175,000.
- New Loan at $131,250 (75%).
- Received back $40,450 during cash-out refinance.
- Total cash in home: $7,250 (4% of appraised home value. Compare to putting down $35,000 (20%) to purchase a fully renovated home at $175k).
Repeat!
BRRRR Strategy Benefits
Using the BRRRR Strategy has several benefits. One is that it mitigates risk. A property’s value should increase at a higher rate than its cost to improve (it is not a dollar-for-dollar increase). In case of a market crash if values drop, forced appreciation will protect your investment. Another benefit is the fact that your property value is now higher. Consequently, there is a lower risk of unbudgeted short-term capex and repairs due to poor workmanship (since you supervise the contractor who performs the repairs). Finally, the BRRRR strategy provides investors with more liquid funds. You can use the cash you withdraw for reserves or to buy additional investments since you are drawing cash.
BRRRR Strategy Risks
The BRRRR strategy offers several benefits, but there are also risks that investors should be aware of.
Your cash may be ‘stuck’ in a property for a longer period of time than planned. The timeline of the BRRRR may take longer than investors expect, so it is important to use funds that are not necessarily needed for daily living. Before performing a cash-out refinance, most lenders require a seasoning period (a set period of ownership).
You may also not be able to pull out as much cash as you anticipated. A weak appraisal, rehabs that take longer or go over budget can all contribute to that. In the end, this could lead to less cash out than planned, or the investor’s cash remaining in the property longer than planned.
Current State of BRRRR in Colorado Springs
The Colorado Springs real estate market is currently in a severe seller’s market due to increased demand and decreased supply, which ultimately results in higher prices and lower margins between after-repair value (ARV) and purchase price. How does this affect you? As an investor, Colorado Springs is not a conducive BRRRR environment at the moment. While it is not impossible today, it is rare to find something that fits this strategy.
Reserves and Contingencies for Colorado Springs
Real estate success stories and failures are frequently discussed, but rarely anything “in between”: surviving a storm, taking minor damage to your returns but still surviving. You should always be on the defensive during turbulent financial times to avoid losing the hard work you have invested in building a large portfolio of real estate. Therefore, investors must understand how to strengthen the protection of their real estate holdings for future generations.
Landlords’ concerns tend to evolve into macro concerns as their portfolio grows (What if the market crashes? What if there is a rental unit surplus?)
We have developed a three-tiered approach to diminish my uneasiness:
- Vacancy: What would happen if I had to rent at a lower rate to get someone in my property?
- Expenses: What would happen if I experienced a lot of capex and repairs during a time of trouble?
- Equity: Lastly, what would happen if I had to liquidate my real estate holdings as a last resort?
The past decade has seen the real estate market grow rapidly, and it is easy to think that real estate is infallible. It is important to understand that it is a matter of ‘when’ and not ‘if’ these uncertainties become reality, and how an investor is prepared will vastly alter the outcome of the viability of their portfolio for the future.
- Vacancy
It’s a profit killer when you have a vacancy on your rental property! Every month that your property is vacant, you as the owner must bear all of the costs (mortgage, taxes, insurance, repairs). It’s important to buy a property that can cash flow adequately, so that in case of an emergency, you can drop rents and still cover expenses, but without putting any money into my pocket.
- Expenses
There might be periods when rents are low and vacancies are high (meaning that rent is barely or not covering all operating expenses). That is when Murphy’s Law says several furnaces and water heaters will need replacing.
- Equity
It is a great way to scale your portfolio quickly using the BRRRR method. We have a rule that is not asset-specific, but rather portfolio-wide
