I had a lengthy post about the story of gentrification in west Oakland two days ago, and you can see that here: http://www.biggerpockets.com/forums/311/topics/193883-the-story-of-gentrification-part-1-how-to-spot-it . After spending that time talking about how it happened and how to spot it, it’s time to go into detail about how I and others were able to take advantage of it.

As a quick recap on how gentrification happened in west Oakland, the tech industry grew like crazy in San Francisco, pushed out artists into Oakland. At the same time, the mayor of Oakland had a big policy thrust to encourage downtown development. Downtown Oakland rapidly gentrified, then North Oakland, and finally west Oakland. They gentrified because of their amenities (access to San Francisco and restaurants/shops). At the same time, lack of land in San Francisco coupled with growing tech demand pushed those aforementioned artists into west Oakland, then middle income folks, and finally the Googlers and other upper-middle-class.

This process took place over a period of about fifteen years, during which prices generally tripled. Some of that was due to differences in level of finish, but most of that was due to the new class of buyer that was moving in. Now, the question becomes, how does one make money from what is a long and involved process?

Clearly, the strategy is to pursue a longer-term vision when you’re attempting to extract value from gentrification. The same caveats apply with gentrification as with other real estate ventures—to dilute risk, engage in a variety of different endeavors. Hold in a couple different areas. Don’t put all your eggs in one basket, because that’s a risky venture. Do whatever you can to minimize the risk.

In order to follow this strategy, I would recommend a three-tiered plan of attack: lots, rentals, and expandable houses.

First of all, lots are inherently the most speculative, and therefore most risky. A lot is nothing but the inherent value of the land. However, the one advantage that most lots have to rentals and expandable houses is that they're much cheaper than buying a constructed building. You won't get the same level of cash flow, but it's a much lower barrier to entry. If you'd snapped up ten lots in west Oakland in 1999 for $10,000 and sold in 2015, you'd have paid taxes for 15 years, (about $150/year) as well as the cost or labor to mow it, and sold for $125K. So that's $10K to purchase a lot, $2,250 for taxes, and a sale of $100K, for a profit of $87,750 (assuming you're doing the mowing). These prices are taken straight from the MLS data for those years.

That lot appreciation is obviously unmatched in terms of return, almost four times your money back over fifteen years for a small initial investment without you having to do much of anything. The danger of course comes in if you purchase a lot that never increases in value. Then you’re stuck with something that’ll take a tax payment every year from you without ever really appreciating. Even more frustrating can be when municipalities crack down and severely limit new construction, as was the case in a few towns in the Bay Area (I’m looking at you Half Moon Bay). When this happens, your prospects for profitable exit are slim.

In terms of monetizing lots while you’re holding them, you do actually have a few options. If you’re looking for a good return, your best bet is likely paving them while you’re still holding onto them. A parking lot requires minimal investment while generating a little return, if you’re in a location with high parking demand and few spaces. Other than that, your options are limited. You can try renting out your lot to someone with a tiny house or a community garden, but those options won’t generate much money and probably won’t be much in-demand if your area hasn’t gentrified.

So lots are your high-risk, low-input, high-reward option. The two other options generate a much better cash flow: rentals and expandable houses.

We’re all familiar with rentals, so I won’t go over the economics with you. Other areas of BiggerPockets cover the basics much better than I ever could. This particular aspect of investing couples really well with possibly-gentrifying areas: if you’re making money in a rental, why not do it in a place that’s also probably gentrifying? The costs of entry are higher, but even if gentrification never pans out, you’re still making a profit. You can also help speed up the process of gentrification by looking for certain types of tenants. What’s not to love?

Lastly is expandable houses. Buying a smaller house on a lot with room to build can be a great option. You’ll get the opportunity to hold onto it and rent it for a few years, all with a positive cash flow. Then if the area does gentrify and building costs are much lower than sale price per square foot, you’ve got an opportunity to add on to the house for a great return.

Here’s the big caveat on all of this though: working in pre-gentrified areas can be REALLY challenging. These areas are typically high-crime, with a certain clientele before they do end up gentrifying. This can present certain challenges in maintaining these sorts of properties. As someone who was born and raised in a similar setting, I’m fine walking in and out of these places, but it’s not for the faint of heart.

We’ve had squatters in our houses, who’ve trashed our houses (or at least tried to!). We’ve had other squatters who wrote death threats all over the walls of the house and graffitti’d “We know where you live Juan Diaz!” on top of porno wallpaper. There are druggies, there’s prostitution, and it’s all going on around your area. That’s the challenge of pre-gentrification areas.

But if you’ve got a protective dog or a tough friend that you can bring along with you, that will go a long way towards easing your anxieties. And I would highly recommend it—investing in pre-gentrified areas is always worth the hassle!

I hope my run-down of ways to take advantage of gentrification has been helpful. Do you have any other strategies for these sorts of areas? Let us know below!