Investments in low income neighborhoods?

Question

So I am brand new to real estate investing, and have about $35k saved I would like to invest. I have been looking around lower income neighborhoods because I would like to start out with a conventional loan. I have found quite a few distressed properties around $60k and below. I am looking to buy and hold these properties, and all the deals I have found seem to meet the 2% rule of thumb. I am wondering if starting out in these low income neighborhoods is a good idea.  I figured $60k would be about my max , so I will be able to put a 20% down payment and still have leftover cash for rehab.

Kyle J. · Answer

Investors can make money in any type of neighborhood, but keep in mind that the numbers can look a lot better on paper than in reality when talking about lower income neighborhoods.  Things like higher-than-average vacancy rates, evictions, turnover costs, etc can really eat into your expected profits.  Also, there's definitely a difference between "low income" neighborhoods and "war zone" neighborhoods.  So make sure you know what you're getting into.  I'd avoid anything that would be considered a war zone, especially since you're just starting out.

Good luck.

Michael Lee · Answer

Hello and welcome to BP!  I only have made one investment deal but I have a bunch of construction business experience and I had a broker license for about 30 years.  If that area is a "crime scene" I would stay away.  Would you feel safe there at night?  If not, I would stay away.  Not that some people will make money there I would steer clear from it.  If it is not in a bad area it counts on how the analysis numbers look.  Good luck to you!jj

Michele Fischer · Answer

Brandon,

Renting to low income tenants is riskier, but provides a better return.  Here are some pros and cons:

Advantages of low income:

Lower property investment cost. $/square foot and square footage is lower, so purchase price and repair costs are lower.  Our motto quickly became “safe and clean”, allowing us to stay focused on using the cheapest products available in rehab.

Higher occupancy rates.  Applicants are often living with friends or family, so are often able to move in mid-month, as soon as the unit is ready.  More stable tenants tend to need to give notice, and move near the first of the month.

Lower expectations.  Low rent tenants are willing to live with more flaws, fewer extras, and won’t be as demanding about discretionary maintenance and improvements.

Fewer evictions.  Low income tenants are more willing to move out when the situation gets bad.  We have not had to deal with someone living in the unit rent free for months while we work through the eviction process.

Disadvantages of low income:

More turnover.  Low income tenants are not as stable, so they tend to move more often.  Even some of our best tenants have become nightmares at move out. Dealing with move out, unit rehab between tenants, and prospective tenants is a huge time, energy, and cost drain.

Higher utilities cost.  Water/ sewer/ garbage is about the same cost for a 500 square foot unit as it is for a 3,500 square foot house, so utilities become a bigger percentage of total rent and costs with smaller units.

Collecting rent is time consuming.  Very few tenants mail us a check or deposit the funds in our bank account.  Some bring the cash to our front door, more have us come get it at their front door, and both involve texts back and forth to coordinate schedules.  We often have to initiate the conversation to find out where rent is, and we often have multiple trips to collect partial rent during the first two weeks of the month.  We admit part of this is due to our desire to visit the properties more often and our willingness to be flexible for our tenants. It may be possible to set expectations and have low income tenants pay less hands-on, but it is a consideration.

More difficult to screen applicants.  Most of our applicants have no bank accounts, have terrible credit, and it is difficult to know where they’ve really been living.

Lower loan amounts.  It is more cost effective to mortgage and refinance one property worth $150,000 than two properties worth $75,000.  The inspection and appraisal costs are about the same for a $30,000 house as a $300,000 one.

Easy to over improve.  It is so easy to get into the trap of wanting to get the property to the standards you would want to live in.  Such spending brings risk of being destroyed by tenants or never getting the value out at sale.

Brandon Johnson · Answer

Oh ok, I never really thought about bring a contractor along with me to check out deals. That sounds like a great idea and makes a lot of sense though.

I also am pre-approved , and my goal atm is to bring in at least $200 in cash flow per unit. Like I said I am new and have never done any deals , so I really just want to kind of play the field and take it slow on my first deal.

I have quite a few properties in mind and I will be sure to try your technique when I go to view them. How much do you usually pay your contractors to come do this initial inspection with you?

Edgar Claudio · Answer

Hi Brandon,

I own 1 property in a lower income area and it cash flows well.

Assuming you're already pre-approved, I'd make a list of the properties you're interested and walk them.

When I walked the properties that I was interested in, I took along a handyman and a friend. My friend took interior/exterior pictures and notes, while the handyman/contractor called out issues/problems and their estimated costs. Average time spent per property was 15-20 mins. When I got home that afternoon, I reviewed all the pictures and notes carefully and calculated all the rehab costs. I then consulted with the real estate agent on my choices and submitted my offer(s).

Let me ask you this Brandon, after all monthly expenses, do you know what you want to cash flow per door? For me, my minimum cash flow per door/unit is $350.

Thanks

P.S- I called a few contractors off Craiglists and found one that  I paid a flat fee to walk the properties and provide written estimates.