Are very small, very cheap single family homes good rentals?

Question

I'm itching to jump into my first real estate investment for rental property. One type of property that strikes me as a little unusual is something like:

~800-1100 sq ft

2-3 BR, 1-2 bath

Small lot, maybe a detached garage but usually not

Price of <$60,000

I'm looking in a city where the average home is about ~160k and I see a lot of these very small, apartment-like homes for sale in the 50-60k region. These seem like a gold mind to me in terms of cash flow, but I see several of them in seemingly good condition languishing on the market for months when more traditional homes in the city are under contract within days.

For example, here's one such house I'm looking at that is very common around here:

Asking price: $52,000

908 sq ft, 2 BR, 1 bath

No garage, small lot, siding/roof are <3 years old and mechanicals are <6 years old.

I toured the house and it was shockingly clean. There were a few drab areas where it could use some new paint, but nothing too wild. It has been on the market for 3 months with price drops from 70k down to current price. I spoke with the realtor and he said it's just a difficult house to sell due to the size, which to me seems ideal for a rental. I also have pretty extensive experience in home construction and spent a solid hour touring the house and couldn't really find anything significantly wrong, like a crumbling foundation or major wood rot.

When I look at comparable rentals in the area, it's not uncommon to get $800-1,000/mo + utilities for a similar 2 BR/1 BA apartment. At this price, the mortgage and insurance would be <$300/mo (if I didn't just buy it cash), leaving $500+/mo minus vacancy, maintenance/repairs, etc. to come out ahead. For such a small investment, these seem so ideal.

And yet I see 8 of these types of homes on the market right now varying between 15 days and 6 months on the market, which is super unusual around here. Despite my desire to think I'm the only one smart enough to spot such a deal, I think that's unlikely. Why are people passing on these houses for investment purposes?

Mike Hanneman · Answer

@Jeremy Chaser and @Francesco Barbati the issue with buying them for "cash flow only" is what would be your exit plan/s? If something happened and you would have to sell, if you didn't buy right then you'll be taking a loss.

Even to buy for cash flow you need to make sure you buy right. The most important thing about investing in real estate is to make sure you have allowed yourself multiple exit strategies i.e. renting it out, being able to sell and make a profit, (or at least not lose money), etc...

Scott Schultz · Answer

The properties you describe are my bread and butter, people love having a house instead of an apartment, the only thing I would say, you have to buy them at a STEAL, what you described i probably wouldn't pay over $30K for even in your location, because its market value is obviously at or below $52K as an on market property, so you buy it for $52K you cant sell it till it appreciates, because of cost to settle, there are plenty of great below market deals, you just need to look in the right places, im in a very rural area, and I managed to buy 14 deals in 2016 and 3 this year already, I buy at Sheriff Sale and online auctions mostly, but you need access to cash to close for those, so you need equity lines, or cash on hand. Good Luck! and this is just my opinion, and may not be right for you.

Michele Fischer · Answer

What does the rest of the block look like?  You do not want to buy the best property on the block.

Is this a low income neighborhood?  What are you seeing on Craigslist for nearby available rentals?

You may have a vision of a young professional single person renting it out, when in reality it may be a big family with sporadic income and a lot of turnover that you may be dealing with. But, if you fence it and allow a wide variety of pets, you may have an interesting niche.

You may be able to get great cash flow, but you are probably going to have to work for it.  Don't underestimate the neighborhood and surrounding properties.  Consider stopping by the police station to talk to the community officer about the area.

Account Closed · Answer

I have two of these...am working on rehabbing a third....I'll provide perspective.

First house I bought for $22,500 and have about $55k total into it.  It will retail between $70k and $75k.  It rents for $725/month.  It's a 625 sq ft 2 bedroom 1 bath home on a huge lot.  First applicant lied on the application...and was convicted as recently as last October for burglary and theft (with previous warrants listed).  Another applicant was a couple that provided the hotel manager at the hotel they've been staying at for a reference.  Combined husband and wife income is about $1,700/month and they asked if they could make payments to cover the deposit.  Husband also sends money to his mother out of state to help her with her mortgage.  Third applicant is a manager at a national agricultural company with great income who asked if he could wait until March 1 to move because he really needed to give his prior landlord notice.  Third applicant is who I approved with the help of the management company.  The house will sit vacant for two months...the third applicant wanted a 6 month lease and I was good with it based on his application.  If he keeps the place reasonably well, I would have no problem dropping the rent price for a one year renewal.  Zillow states this house will rent for $1,040/month.  Don't believe everything you read on the internet - you aren't renting to Zillow :)

Second house I bought for $7,001 and have about $15k into it.  It will retail for between $30k and #35k.  It's an 850 sq ft 2 bedroom 1 bath house.  My property manager is absolutely awesome for this property.  We have Section 8 tenants.  Dad brings in $1,800/month.  Mom does not work - she takes care of their two young children.  This house rents for $600/month.

Third house is 1125 sq ft.  I paid $4,000 for it.  It will retail for $60-$65k when I'm done....I have about $20k into it and it needs at least another $10k worth of work to get it rent ready.  It will rent for between $700 and $725 per month.  My goal is to have it ready by the end of June (rounding up contractors from a few states over is like chasing chickens and just as time intensive).

If you go out and look at some of these houses after they've been rented and see how people live, it will be very disheartening to you.  I can't tell you how many times I've said to myself, or to my friends "I can't believe people live like this".  The reason I've decided to be in this market is...

1) I have property managers that take pride in the properties.  They would never hand their sign out on the front lawn if the places were trashed.  If something is broken, we fix it.  We have the utmost respect for our tenants and we expect the same in return.  We are selective in who we rent to.

2) As you can see, I buy low.  Very low.

3) I calculate my capex reserve as being equal to my monthly depreciation expense and I factor this into cash flow.  That second house will need a new roof in the next two years...a new roof is going to run about $4,500.  That's about 30% of what I've put into the home and it will take about one year of rents (net) to cover that expense.  I have time to allow for that.  I'm not worried about it.  Most houses will pay for themselves every 8-10 years or so.  I estimate the same (though gross rents would say the house pays for itself every 2-3 years).

It's not for the faint of heart and I would say it is riskier than the average rental.  Think about this - I just described to you a portfolio of properties that will bring you gross rents of about $2,050 per month...or net rents of about $1,000 month at the most net (if things go well).  That's a net income of about $12,000 - not much in the grand scheme of things for all the trouble to go through with paperwork, rehab, etc. and saving for the next deal.  I have a full time job that supports this....I can afford to buy another few of these over the next 5 years and hopefully fund a comfortable retirement...which really won't be because I'll be dealing with all these smaller rental houses :)

The other option is to buy a portfolio of these homes from other investors - there are a ton of them out there as "package deals" where for $425,000 you can buy 6 at a time or so.

Thomas S. · Answer

The problem is that SFHs are very expensive to maintain having only one tenant supporting your business per property. A short term vacancy will wipe out most positive cash flow and major expenses like a roof or HVAC will do the same. If lucky you will possibly have $100/ month positive cash flow long term which is barley worth the trouble of having to deal with tenants.

Your second problem will always be the class of tenants. C class tenant will likely be your market and C tenants in a SFH is a recipe for disaster. They are very high maintenance tenants, very demanding, very destructive, having very low social standards. They are basically the bottom of the barrel by way of tenant quality in many cases.  To maintain cash flow you must be very hands on with managing your properties. It is imperative you strictly inforce the lease especially when it comes to rent payment on time and you must (mandatory) do, at a minimum, quarterly full inspections of your property. Never use anything except M2M leases as you will need to be able to quickly remove non performing tenants. Vacancy rates will be higher on average if you intend to protect your business interests. Low quality tenants means intensive hands on management to prevent the worst ones from gutting your property.

Scott Schultz · Answer

So if you buy at market, what happens when the market shifts? the markets are cyclical, I will only buy with a Minimum 40% upside, generally 50+% ARV, and I never borrow more than 60% LTV, this allows for a 20% market drop, and i still have a remaining 20% if i need to Refi.  In 2008 lots of investors lost everything because they bought at the top with no equity and couldn't sell or refi.

As far as sheriff sales, are you looking at opening bids the day before sale, or just judgements? im gona pull a Rober Kiyosaki here, like he says to a lot of people on Rich Dad Radio. You have to decide what type of investor you want to be and you need to get educated.

Jeremy Chaser · Answer

That's interesting - you wouldn't buy them even just for the cash flow? I figure at 50k those kinds of houses will cash flow very positively. I have no idea how I would go about finding a house like this for 30k :S I looked at the sherriff sales around here but I don't really see much of deals for sale.

Francesco Barbati · Answer

I am not an experience investor, but what I would be more worried about is to make sure that this properties rent, beside the fact that they sell or not.

Are very small, very cheap single family homes good rentals?

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