Why would anyone want to buy an rental if you have to put 50% to make it break-even?

I received this comment to my recent post,

Yountville 2008 Real Estate, The Year in Review by Curtis Van Carter on January 14, 2009:
Hi, Thanks for the info, very interesting stats. do you think demand may increase in the coming months as people are thinking about investing into the housing market in Napa Valley rather than money market/wall st/bonds? thx, tracy

And my reply was:

Tracy
Napa Valley is a very unique place, thus prices are higher than many other areas in California. Prices are less here than in Carmel, Santa Barbara or the San Diego coast areas, but high enough to not make the best sense for investment properties. In Yountville and St. Helena one needs to put 50% down for most properties to break-even as rentals. I have always used as a rule of thumb, it a very good buy if you can do this with 20% down. The saving grace, there is a limited amount of property here and it is a true enclave which tends to have better and more stable appreciation than many other areas. Plus, if you have to ever move into one of your rentals, there are very few better places I would rather be.
Demand in most areas of the Napa Valley is still being driven by price with foreclosures/distressed sales representing about 50% of all sales. It feels to me we are close to an equilibrium now, thus I don’t expect a great increase in the demand for the next 4-6 months. It is truly a good time to look to buy and the Napa Valley is no exception just with it own nuances. Please feel free to contact me directly if you would like to go into this more. Curtis

This started my mind thinking and I realized an expanded response was needed. Thus this post and my justification why anyone would want to buy an investment property in the Napa Valley, especially Yountville, where prices are nearly the highest, St. Helena holds that distinction. First, lets examine what it takes to make an investment property break-even.

In order to do this, I had to make certain assumptions and try to put this into the best perspective possible. Thus I chose what I consider the best deal which has recently sold here, 35 Forrester Lane. This Washington Park 2 bedroom, 2 bath, 1,069 SF home closed escrow for $515,150 on August 8, 2008 and would rent for $2,000 per month. I used current interest rates for a rental property as quoted by the mortgage broker I use, Mortgage Solutions, and actual property tax rates, management fees, etc. A couple of other assumptions: I used a 40% Federal and State income tax bracket and a 2% annual appreciation. Being the annual increase in property tax assessments for Napa County for the last 35 years is nearly 7% , the 2% I used is in my opinion very conservative  and factors into the proforma, a prolonged period before any true appreciation. Also, I considered this investment as a 5-7 year hold and then selling the property without considering selling costs. If one considers selling costs, the RETURN ON INVESTMENT would be slightly less than the 3.87% my proforma shows.

Below is my proforma for the property.

Being as I stated above in my reply to Tracy, what I consider a very good deal, and what I generally like for investment properties I would purchase, is to put 0nly 20% down to make it pencil. Then why would anyone want to buy something you have to put 50% down (49.63%) for it to break-even after Federal income taxes. The reason, this is Yountville. Every day, there are buyers roaming through the properties for sale here and buying without hesitation. Yountville is one of the true enclaves left in the California were the likes of Thomas Keller call home. This is a special place and only a select few, the population including the Veteran’s Home is about 3,500, reside here. Two more commercial projects and about 10 homes and we are built out. This is excluding one large lot owned by the Catholic Church which I don’t think will be built on in my lifetime.

Granted we need rain, yet as I sit in my office with the door open experiencing the nearly 70 degree weather, I can’t think of many other places in the world I would choose to call home. Thus, my reasoning when I tell Tracy, it is worth every extra penny. Yes, there is a price I pay to live here, and yes there will be many who cannot afford it. Thus I truly thank all who allow me to do so and will continue to express this to all who I come across in my roll as a Realtor here, selling this slice of Heaven. The demand for homes here does have its ups and downs, but one thing for certain, there will always be a demand. Tracy, I hope this helps.