Strategy ~ Are you crazy to buy in good areas right now?

Question

Hey gang,

So this is a general question that I thought I'd get some interesting feedback on (or maybe none), and it's one that some will interpret as procrastination or over-analysis, and I'll preemptively say it's not, it's a question about strategy (and I can't afford A markets currently anyways...)

This is something of a weird time to enter the marketplace, knowing enough investors who weathered the storm, lost a great deal, or acquired their whole portfolio after the crash, I hear about these deals and the ease of finding them, but there's obviously nothing like it on the open market (read MLS) today. And, in fact, after closer analysis, many of the higher end areas look like horrible investments. I mean piss poor with cap rates at 2%, negative cash flow, and properties that will inevitably deteriorate because owners have never heard of CapEx or even property maintenance.

This question is more with respect to buy and hold (my play), because flippers obviously look to capitalize on strong markets and low inventory, giving a quick sale and maximum profits. But for the 'high end' investors I see time to time on BP who trash 'cash flow' C area investing, when I'm currently looking at the market it genuinely seems to make more sense.

I was doing on MLS search on one of the A markets near me and analyzing sales between 2010 and 2012 - some properties were selling for 1/3 of what they're currently trading at, and there was a short sale or foreclosure every other listing. If you guys were buying cash at the time you're probably retired now, on a yacht somewhere...

I've been working as an agent and closed a few transactions with some better ones in the works, but where to put my cash is the question (I don't have tons). I have a C property under contract that needs rehab, I plan to occupy, has a ridiculous cap rate on paper, and should be fine if negotiations come together. But I've talked to some 'higher end' investors recently who said they would've skipped the junkers all together and moved to the bigger stuff, but isn't that a terrible play right now?!

Are cash strategies, wholesaling, whole-tailing, flipping, slanging real estate (working as agent), or buy and hold C areas the best play in the given market? My 1-2 year plan was buy cheap properties. Recent conversation had me rethinking it. Analysis of better areas has me rethinking their advice.

It seems the best advice in the given market could simply be: save your cash.

BUT, who knows when it corrects? Who knows what kind of fall out we see, if any?

I guess one general takeaway could be don't shop on the MLS...

What are your thoughts?

Best,

JTM

David Faulkner · Answer

I think you are on the right track ... I've bought in nice neighborhoods and I've bought in not so nice neighborhoods, and have done well in both ... but know that in my 15 years of investing I've always done much better in the long run in the nice neighborhoods, even though the not so nice neighborhoods cash flowed better on paper day one. So, I'd advise only buying in neighborhoods where you would want to live, even if you don't plan to. And yes, the greater returns came from both appreciation of prices and rents. However, I would say do more than cross your fingers ... actually look at the historic average rate of appreciation and rent increases over multiple cycles (20+ years) and underwrite to that ... a good property manager, real estate agent, or appraiser who has worked in that market should be able to help with that, or heck even zillow for long term averages (just no zestimates for individual properties). Finally, run your numbers like a flipper as well to get some forced appreciation. A $50,000 forced appreciation equity bump will make up for -$200/mo cash flow for a long time (20 years), and by that time rents will likely increase to put you significantly positive, you will pay down the mortgage significantly, and alternately you can likely sell at profit if you need or choose to at some point along the way. As a bonus, your tenants will be low maintenance and turnovers will be easier and less frequent. Quality over quantity ... this is how I prefer to play the game personally. YMMV

David Faulkner · Answer

I think the opposite of what you are thinking ... I think now is a crazy time to buy in the lower end areas. In my market and I would guess in most, the lower end markets are less stable and when a downturn hits, they are the markets that get hit hardest across the board, with prices, rents, vacancy, everything. So, I think now is the time to focus on quality as those markets will fare better in a downturn. This is because tenants and owners in those higher quality markets tend to be less paycheck to paycheck and so they are not forced to get evicted or foreclosed on at nearly as high a rate as the lower end markets. After a downturn, that is when it is best to go with lower end markets after they get hit hard. I would also recommend being either flexible or patient with your strategy, with being flexible being the best since you can adapt your strategy to what the market has to offer, but if you are not willing to do that then be patient for your preferred strategy to match the market. For example, I prefer buy and holds too, but the flipping numbers make way more sense to me right now so I'd rather flip then wait sitting on my thumbs or worse yet try to force buy and hold deals. Also, the two skill sets compliment each other and give you more ways to make money even on the same deal. If you don't want to or are unable to flip, you can just continue working as an agent for now to capitalize on high prices that way and save up like crazy.

Shawn Ackerman · Answer

@Joshua Martin it's never a bad time to buy real estate.  doesn't matter the area.  All that matters is the purchase price and how motivated a seller is.  I think finding deals on MLS is becoming increasingly difficult especially when you have an agent (middle man) fogging up the road.  No offense, I'm a realtor here in NY but I think an agent's time is better spent on retail owner occupied properties.  Let the investors work with the investors LOL!!!!  I've purchased a couple of deals off the MLS and found that the owners are really firm on pricing but because the properties were solid I bought close to asking and nearly at market.  Now when I find motivated off market sellers that's a whole different baaaaaall game!  60% - 75% below market is not uncommon in these situations.  As I always say to you my friend.  Persist and you will WIN!

JD Martin · Answer

My take: your strategy is to buy when you are looking to expand and there's a good deal to be had. The trick is recognizing a good deal. There are a lot of markets that people thought $X was a crazy amount of money 5 years ago, and that looks like a bargain today.

As for areas, I don't personally see that there's any blanket way to designate A-F housing stock geographically across the US. For example, the worst housing stock areas in my area is probably a safer bet than the worst housing stock in, say, Camden NJ. And "A" stock housing in my area is nothing compared to "A" stock in NYC or Boston.

Matt R. · Answer

Maybe 80% of the nation should be ok moving forward and almost regardless if good or not so good area. This is likely the results of GFC and the after effects of the lack of new housing that followed GFC.

In Cali, the good areas usually outperform the not so good by such a significant margin that if you can go to the better locations the results could be very meaningful long run. At times we are talking hundreds of thousands of dollars as an average difference or even multi millions in a redevelop phase case.

Jeff Keller · Answer

Hi @Joshua Martin I don't have good statistics to back it up but my impression is similar to @David Faulkner's comment. Properties with issues have prices hurt by volatile markets. During a downturn their prices go down quickly. During an upturn they are slower to rise but most often come back up to the previous ratio they had relative to good properties. The swings in prices tend to be larger.

So if you are good at timing the market you could do well with "problem" properties. A better, but hard to achieve, strategy would be to take advantage of the different timing of the rise and fall of prices between good and problem properties, switching from one to the other so that you have cash to buy a problem property at the bottom, but move it to a good property after you have reaped the increase.

Andreas W. · Answer

A class properties in my area simply don't cash flow. It is a pure appreciation game that costs you money up to selling them. Since good deals are being made at acquisition, I personally would not invest in A class properties now. In contrast, I would think about cashing out of them if I had any. I agree with C class characterization from above.

Thomas S. · Answer

I prefer to invest as opposed to speculate and believe B class is the absolute most stable market. There will always be tenants in every class regardless of the economy it simply comes down to the difficulty of managing the C class when times are tough. When C class tenants have nothing to lose they will always choose to blame the rest of the world and screw whoever gets in their way.  B class when times get tough will move down but there will always be more than enough tenants in either class to sustain long term investments.

A class is for speculators with lots of money. They do not live off of their income and could care less about cash flow since there is usually none in an A class investment. They are simply a different type of investor than those investing for income as the majority of investors do.

Leave the A class to those more interested in speculating on appreciation if you are investing to pay your bills.

Jamie Engledow · Answer

I think cash flow is the best strategy for investment in rental properties.  However, in my case I want to purchase a duex through fourplex for myself and children to reside in and therefore it must be in top school rating area, so I just restricted myself to an A neighborhood.  In todays market even if someone was renting out my unit, I would probably still negative cash flow $100 or so.  Maybe not a smart idea, but I criss fingers for appreciation!  But, for future investments I will focus on only the cash flow, no matter the neighborhood rating.

Strategy ~ Are you crazy to buy in good areas right now?

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