Should I launch my REI Career in a distressed area?

Question

Hey all, glad to  be a part of this board. I am fresh out of college, and early in my career.

I have always wanted to invest in real estate, since I was about 12. I am learning more and more each day. I am reading "Investing in Real Estate" by Gary Eldred to gain some knowledge.

Here is my dilemma. I'm not sure where to begin investing. I live in Northeast PA, and houses are not very expensive here, rents average about $550 per month. However the area is not very nice. A lot of areas are distressed and getting worse in the future i would believe. Also the houses are very old 1900-1950's.

Personally i would prefer newer houses and nicer houses. I want to invest in something i would live in myself. What do you guys think? Those with experience is the price enough to offset your decision? I know that when investing, appreication is a huge factor, and you want to invest in an area you will believe will appreciate. I personally cannot pick an area, except for near a university, that i believe will appreciate in the future.

To give you an example of the prices. There is a 4 Unit on a shady side street that is fully rented, grossing 25K per year with 5K operating expenses, the owner wants 125K. Seems rather cheap to me, but if you saw the area i doubt you would want to purchase it.

But even still if i could purchase it and have it pay for itself is it something i should go for regardless of the location? My gut says no

Jon Holdman · Answer

The goal of owning rental real estate is to make money.  Do some reading in the Rental Property forum about the reality of this business before you do anything.

Investing in some of these depressed areas can be quite profitable.  Investing in "newer and nicer" houses can be unprofitable.  In either case, you have to be sure there's demand.  If half the house are boarded up, there's no real source of jobs in the town, and people are moving away, it probably doesn't matter what you buy.  There's no demand.

Your example fourplex appears to be generating $520 per unit per month.  That means you can afford to pay about $25K per unit, $100K for the entire building, and be profitable.  The operating expenses are NOT $5000 a year.  More like $12,500 a year.  I don't care what the owner is telling you, $5000 is not what you will experience.

Account Closed · Answer

Where ever you invest you will want to learn the market very well.  I like to drive around the neighbors to see what might be up for sale, see the general condition of the homes, look for vacancies and get a sense for what is going on in the area.

It is a good idea to know what value differences you might expect from one neighborhood, block to another.  I like to get an idea of what difference a view might make.

If you know what the norms are anything out of the ordinary jumps out as a potential opportunity that might be worth investigating.

I don't necessarily buy into the idea that a home bought in a distressed area will have greater cash flow.  You may find that you have higher expenses because of vandalism or other damages.  You may find illegal activity taking place in your rental.  You may have difficulty finding good tenants.  You may have higher vacancies if jobs are hard to find.  In short, you want to do your due diligence and learn what to expect.

Bill Patterson · Answer

There is a difference between buying shoes â€œwholesaleâ€ and providing a storefront and knowledgeable sales people then selling retail and buying a rundown, dated house and rehabbing it then selling at a profit.  It may be closer to your manufacturing example or home building, though.  Every investment has to have something happening that causes the investment to appreciate.  Company stocks appreciate along with the profits of the company.  They lose value as the company profits decline or they have loses.  Rental property value goes up mostly with the associated income.  How does this happen?  With improvements to the property, good management, a strong rental market, etc.  Other than the strength of the rental market, the rest is labor and materials.  This is similar to the labor and materials that go into the rehabbed house.  You still have to buy the property at a low price and invest in the improvements that will best increase the value.  There are still market conditions that affect the eventual price that you may be able to sell for and receive a profit.  You could hire a contractor, the same as you can hire a property manager to lessen the amount of involvement in your investment.  From my point of view, someone has to be â€œturning the crankâ€ somewhere to generate income.  Even with a CD, someone is lending your money out, making a profit and paying you a rate of return.  In a sense, you are paying for them to provide the labor of doing so.  You could be making private loans and achieving a higher rate of return for your labor and possibly a different risk level.  Suppose you purchased an apartment building with a 25% vacancy rate, even at below market rents.  You hire a contractor to rehab the property, put new management in place, evict non paying and otherwise bad tenants, increase rents and change your vacancy to 5%.  You then sell it a year later.  Is that a business or an investment?  What if you hold it for 3 years?  Is it the amount of effort you put in or is it the length of the hold time that determines if it is an investment or a business?

Investments are made in every aspect of your life.  You invest in your education, business, relationships, hobbies, health, etc.  When you are investing in real estate, be it rental property, raw land, REITs or buying, rehabbing and selling property, in my opinion that would be real estate investment.

Bill

Jon Holdman · Answer

Fix and flipping is an investment in the same sense a shoe store invests in shoes.  The shoes are inventory, and any business that buys goods at one price and sells them at a higher price needs to maintain an inventory. I'd consider fix and flipping (and developing or building houses) to be a manufacturing business.  You bay raw materials and turn them into a more valuable product and sell it at a (hopefully) higher price than the cost of all your inputs.

You're right that rental properties have a couple of associated businesses, property management and maintenance.  If you do those parts of the business, you earn more money than if you hire someone else to do them.

An "investment" is something you put capital into an get back a return.  Bank CDs, stocks, and bonds are all examples of investment, as are rental properties.  Rental properties are one of the few investments you can buy with leverage.  In doing the math, rental properties rarely produce adequate returns without leverage.  You can do this, to a limited extent, with stocks.   But you always have to have enough collateral to cover the loan, i.e., a margin account.

Businesses that maintain inventory very commonly use loans to "floor plan" their inventory.  Every car on a dealer's lot has a loan behind it.  Many small businesses have loans covering at least some of their inventory, either an actual loan or "seller financing" from their vendors.

It is semantics, to some extent.  But there's an important point, too.  A business is something that produces income ONLY when you're actively turning the crank.  A business is like a job in that sense.  An investment produces income without the need to turn any crank.  Investments are what get you to the guru dream of just setting at home, or on a beach, and waiting for the money to roll in.  Businesses do not.

Bill Patterson · Answer

Fix and flip is also an investment as well as a business, albeit a short term investment (if all goes well!).  Although, at least in Michigan, legally you can only do 3 deals before you are classified as doing real estate as a primary vocation or business and need to be licensed.

Any way you look at it....to be successful in real estate you will need to do your homework and put in the effort.

Bill

Jon Holdman · Answer

I think that's a good strategy, if you can pull it off.  Fix and flipping is a real estate business, rather than an investment, IMHO.  You may have money you invest in the business.  By business, I mean something that produces income as long as you turn the crank.

Rentals, OTOH, are an investment.  You put in your money and you get back a return on that money.  You use money you've earned from other sources or existing rentals to expand your portfolio.

Paul Rinaldi · Answer

Thats a very good point about SFR. I hadn't thought about it like but i'm glad you said it, it makes a lot of sense.

Personally I would love to flip houses vs renting, just because of the faster return. But i know that the reality is not as easy as it sounds. Finding a potential Flipper is something that i have to research more.

ideally, i think i would like to flip to build up cash, then purchase a larger rental unit 6+ units

Jon Holdman · Answer

When you're starting, buy SFRs.  Why?  Because there's a chance you decide the landlord business stinks and want out.  Lots more buyers for SFRs than anything else.

I would not buy in an area where I feel unsafe.  That said, lots of people do consider the areas where I have properties to be unsafe.  Reputation isn't reality, however.  There are families with small kids and those kids play in the streets and drive their little electric cars around at 10 PM in the summer.

You need to decide what you want to do.  Not sure what you mean buy "longevity", but buying houses you intend to sell is a different business than buy and hold.  If you buy rental properties and let the tenants pay them off, at some point you have a relatively valuable asset that's generating cash.  Appreciation might be there, but you really don't care unless you want to refinace or sell.  If you're buying and selling, they you're flipping.  That's a different business than landlording, even if you do rent it for some period of time.  For flipping, you do want to look at possible appreciation and the sales market, and any cash flow from the rental is gravy.

Keep in mind that appreciation has, historically, just matched inflation.  Even the new Case-Shiller data that's just out  supports this.  It appears we've just about worked off the bubble and prices are where they were 10 years ago, adjusting for inflation.  Don't plan on anything like this insane bubble happening ever again. If flipping is your business, you need to figure out how to create the value improvement, just just rely on external forces.

Paul Rinaldi · Answer

I have heard this before. But what about Longenvity and Resale?

In the book im reading Gary Eldred tells how he is much happier investing in properties that suit his interests, which happen to be SF's and Duplexes. He might not make as much, but he enjoys what he does more so it's a fair tradeoff.

I think this is how i feel on the topic of owning in a ghetto area. The money may be good, but i would not be satisfied with owning that property because of the location.

But my big concern here is that 90% of the properties in my area are similar to this, at least the cheap ones...

Also i'm not sure if i should go for a SF, MF, or Duplex

Peter Hans · Answer

i can't give you a qualified answer however...

the more shady/ghetto the area you are investing in the higher the cashflow

Should I launch my REI Career in a distressed area?

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