Is it a bad idea to buy rental properties in a high-end area?

Question

Many investors seem to be looking for rental properties in areas with low property values. This makes sense given that rental returns tend to be much higher. For example, I live in downtown Chicago and found that returns generally increase with the distance to the city.

But what exactly are the downsides of investing in less desirable areas? Some people are concerned that property values will appreciate less, but is that really true? Is the main disadvantage that property values are more volatile (so you would get hit harder in a crisis)? And if that's the main difference, could you achieve similar results by buying in a high-end area and using leverage (borrowing money)?

I'm curious about your thoughts on this!

Nico

Kyle Scholnick · Answer

Like most things in life, you need to find a balance. I am not comfortable at either end of the spectrum. I don't want a $40k house that doesn't appreciate and has crappy tenants and high repairs nor do I want a $500k property that only rents for $2300 and never cash flow. Call me crazy, but I like doing things right in the middle. Buying properties $80-150k in A and B neighborhoods. You get the best of both worlds that way. I guess I am just not as adventurous as other real estate investors, I just like predictable, consistent and steady returns.

Brie Schmidt · Answer

It depends on what your definition of "less desirable areas" in relation to Chicago. I find a lot of people who are newer to the city think downtown is where it is at, and anyone who has lived here for awhile knows that isn't true. I consider the loop to 1/2 mile west of Milwaukee up to Foster and to the lake to be very desirable. I consider them to be A/B areas which have decent cash flow and a good chance of appreciation.C/D areas are a different story. They are in low income areas with subsidized housing. While the cash flow is high the appreciation is low. The repair and vacancy costs are also a lot higher

Mike F. · Answer

Damn boring people always end up in the long run with all the money. Nothing wrong with consistent and steady!

Jassem A. · Answer

if you buy too high end then chances are that the rent you collect will not cover your mortgage or expenses and the pool of qualified applicants that will want to rent your property may be smaller. If you buy too low end then you will be more likely to end up with bad tenants that will mess up your property and you may have trouble selling the property in the future for the amount you have invested.

Jeff Wallace · Answer

In my opinion and experience, the vacancy rates increase at both ends of the spectrum. A lower end property will have high turnover and damage between tenants and a high end property will have longer vacancy periods before a tenant comes along with the income to support the luxury rent market (Luxury market is defined by drastically different numbers in different markets across the country). I like to own properties that reach the broadest part of the rental population (think of the orange and red properties on a monopoly board vs the light and dark blue)

Kyle Scholnick · Answer

These are 2 extremes that people argue about all the time. Buying expensive property in a desirable area that usually won't cash flow unless there is no mortgage vs. a cheap house that appears to cash flow well. You get what you pay for...if the house is cheap, its not in a great or highly desirable/populated area. You will have a lot more vacancy, more repairs, more maintenance...and frankly the cheaper the house is, it just attracts cheaper and more destructive tenants. And yes that is absolutely true that those cheap houses don't appreciate well at allLeverage doesn't have to do with your analysis. Leverage can improve your returns, but can kill your cash flow if you have an expensive property and once you factor in the maintenance, cap ex, vacancy, insurance etc and now PLUS the mortgage, you may not cash flow at all...You might make money in the long run if the expensive house appreciates, but there is no guarantee....and remember most houses over the long run just appreciate with the rate of inflation of about 2-3% per year

Kyle Scholnick · Answer

I think people lose track of what the ultimate goal is...Yes you can make a killing with real estate, but why do you feel you have to optimize your returns to the highest level or you are doing it wrong? When did it become so foolish to get a solid 10-12% return? Its amazing because many properties will net that, yet people call you an idiot because you aren't getting 14-20%. You are making money. You are doing well. When I invest in stocks, I don't kick myself because I only got a 13% return when I could have sold an option or took on leverage to get 18%....yes you always want more, but as long as you are making gains you will be fine and reach all the goals you want. Its like in blackjack, if you have 19, you would never take another hit right? Even though you still have a 10% chance of losing with that hand, your wouldn't hit...why? Because its good enough! its a great hand, you don't have to try to optimize it with a 20 or 21, it won't make a difference in the long run.

Mike F. · Answer

Not necessarily. There is the other side to just compounding a good return after good return after good return versus trying to knock it out of the park every time and having one great return followed by a not so great one, followed by a loss...

Andrey Y. · Answer

Exactly. Because boring people don't spend the money (isn't this the point) they just look at numbers/zeros on a screen.

Elizabeth Colegrove · Answer

I buy higher end houses in smaller towns were rentals aren't plentiful. Therefore appreciation is still high, rents are great and I still get the higher end tenants and cash flow. There are tons of different strategies :)