Are Properties in the Best School Districts the Best Rentals?

[Eric Fernwood]

Many people make the mistake of assuming they know what will attract a specific tenant pool segment. I made this mistake as well.

When I was first studying tenant pool segment demographics in Las Vegas, I assumed that properties in the best school districts would be the best rentals. However, what I discovered was that in the best school districts, property prices were higher, and there were fewer rental properties. The average length of tenant stay in these properties is less than two years.

At a minimum, I was looking for a tenant segment that stayed four years because, at two years, your vacancy cost will consume most of your cash flow.

So instead of guessing what prospective tenants want, I turned the process around and determined where and what tenants who stay many years are renting today. I wrote software that determined the average length of tenant stay in subdivisions with a significant number of renters. To my surprise, there were subdivisions where the average tenant stay was less than one year and some subdivisions tenants stayed over five years.

I then studied these people’s income. Most made significantly more than minimum wage but not as much as salaried professionals. The majority of this demographic is government workers or direct income producers for their employers and are difficult to replace, so their jobs would be secure even in difficult economic times.

This proved to be true in the 2008 financial crash. Our clients had zero decreases in rents and zero vacancies. While the market value of the properties plunged, our client’s rental incomes were unchanged.

The lesson is that a rental property is no better than the tenant living in the property.

Rather than making assumptions about what's important to renters, it's better to identify the right tenant segment and purchase properties similar to the ones they currently rent. This approach eliminates guesswork when selecting properties.

Let me know if you’d like details or have any questions.

[Eric Fernwood]

Thanks for the great comments on this thread. I will reply to a few of them. First, general comments:

Choosing a property or location and hoping for good tenants is not the best approach. Instead, I identified a narrow segment of tenants who consistently stayed for many years, paid rent on time, and took care of properties. Once I identified this segment, I determined where and what they were renting and then bought similar properties. This approach removes all judgment and opinions from the process.

In Las Vegas, tenants in C-class areas typically stay for about a year on average. They lead cash-based lives, so leases, skips, evictions, or damage judgments have no impact on them. They get paid every Friday, cash their checks, and pay rent and utilities in cash at 7-Eleven or similar locations. Due to their short stays, vacancy costs are high.

Another consideration is that prices and rents are low because there is limited demand. Where there is limited demand, prices, and rents do not increase very fast. So, rents will not keep pace with inflation. Also, in Las Vegas, the rent for C-class housing is loosely tied to the minimum wage. Unless the minimum wage increases, rents cannot increase that much. Also, in such locations, appreciation is minimal.

@John Morgan A handful of our clients tried section 8. None of them continued after the first year. The experience most had was that the government would reliably pay a portion of the rent. But the tenant did not reliably pay their portion of the rent. Also, there was a lot of property damage, which had to be repaired in order to continue receiving government funds. You do get higher rent. In my opinion, Section 8 properties rent for $100/Mo more than non-section 8 properties. However, it's not the gross rent you receive; what matters is your net cash flow. One of the properties required over $15,000 in renovations after one year of having a section 8 tenant. Section 8 is not a free pass. It is an option that must be weighed against all the costs.

@Scott Mac I enjoyed your comments on schools.

@Henry T. We've completed over 70 1031 exchanges and the majority came from California, Portland, and Seattle. We've also had a fair number from Florida and Texas. These were driven by the very high taxes and insurance in both states. Henry, if you'd like to chat about Las Vegas, reach out.

@Joseph T. Miller The algorithms I developed will work anywhere, but a lot of historical behavioral information for the specific tenant pool you want to target is required. Plus, the software can only go so far. You need an expert team to validate, renovate, and manage the properties.