Are Properties in the Best School Districts the Best Rentals?

Question

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 · Answer

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.

Joe Villeneuve · Answer

Yes.  Well said.  I also came to this conclusion after thinking about it, and analyzing markets, noticing all of the same things you mentioned here.

Best school district is great for the tenants that live there, but that doesn't automatically translate to a good place to invest.

Eric Fernwood · Answer

Hello @Brad Sand,

The property data comes from the MLS. In Las Vegas, the vast majority of long-term rentals are done through the MLS. We accumulate historical data over the years to select and validate properties. Unfortunately, no public or paid source provides the hyperlocal information required to evaluate properties.

Brad S. · Answer

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That is similar to one of the first things I was taught when I started my appraiser training, many years ago. Basically, "let the market tell you what the value is, not the other way around." An analogy being, people might assume a 4 bed house is worth more than a 3 bed house the same size, but they didn't bother looking at the data which reflects that buyers want larger bedrooms, or houses with pools, when buyers have infants and don't want the liability of a pool, etc.

Where are you getting your rental data that you are plugging into your software?

John Morgan · Answer

@Eric Fernwood

I stay away from good school districts. My tenants are almost all lifers that will probably stay with me for many years. They don’t move into these hoods for the schools. They move to be close to their jobs and family. I have much higher returns with working class tenants in C+ class hoods. And pretty much zero turnovers. People who rent in good school districts or higher end homes have a much higher chance of leavening you within 4 years. Turnovers eat up all your profits. Go for the lifers. Lol

Bob S. · Answer

I should add, we actually get mor,e much more in rent for the lower-class areas. Now please keep in mind we do 80% various govt programs. They pay you more in the worst areas.

Scott Mac · Answer

To me all the school rating seems to be the obedience to authority level of the students who go there.

I don't think it has much to do with length of a renter to stay put.

Anyone can live anywhere they want (or they or Section-8 can afford).

Forever renters (IMO) seems to stay put longer, if they have market equal housing, are treated like customers vs pests, maintenance requests are handled promptly, and rent increases do not jump too huge for them too quickly (and in some instances do not have relationship issues/breakups or are PITA Renters to the owner or other renters.

A forever renter example might be Mr works retail, Mrs works waitress, kids or not, or Ms. is a hairdresser and sister Ms. is a receptionist, or Section-8 working or not.

A non-long term renter might be Mr. is going through law school or is an MD in the area for residency time, or other person on a career path that typically includes home ownership.

I'm not talking here about any type of protected classes here, which would be against the Fair Housing Laws, because it's important we all follow the laws.

As far as the schools go:

They teach you how to read and writeThey teach you how to countThey teach you how to buy and sellYour own body by the poundDon't be blind to the factThat the hand you holdIs the hand that holds you down.

As I said above, to me, all the school rating  seems to be the obedience to authority level of the students who go there.

It's not that I'm anti-school--it's just that they ALL could be so much better.

It just seems like babysitting and jumping through useless hoops.

Just my 2 cents.

https://www.youtube.com/watch?v=Yk3-Vb7CH-o

Bob S. · Answer

Short answer HECK NO!

Henry T. · Answer

No disagreement with any of that. Spot on. If you're in a state where you can choose your tenant from a pool of best applicants for that property, you will always be whole.  In Seattle where you are mandated to take the first qualified, it's a crap shoot.  I know (odds are) that the couple with a kid, who wants my school,  is gonna stay longer than the single techie who just moved here. However, I'm not allowed to make that determination. I used to, but the law changed. So I quit, other reasons too, but that was a big one. We're closing our doors. I'm off to new horizons.

Are Properties in the Best School Districts the Best Rentals?

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