Why not invest in depreciating markets?

[Abed Asghar]

I have a question that maybe some of you more seasoned buy and hold investors might be able to answer. A lot of the forums/webinars talk about a minimum 12% cash on cash return on rental property investments, but for someone just starting out and living in Southern California, a 20% down on a half a million dollar “deal” isn’t easy to come by, it seems the numbers never add up. But then I look at 3 bedroom single family homes in cities like Detroit MI and Cleveland OH going for $10,000 or less, bringing in a monthly rent of $750 at minimum, why aren’t all buy and hold investors looking for cash flow buy up in these areas? Is there a reason why these properties aren’t moving? Buying a $10,000 property in these slow appreciating markets outright and renting it out for $750 while living and working in Southenr California seems like a killer return to me, but am I missing something? Thanks for the insight BP peeps!

[Andrew Johnson]

@Abed Asghar A lot of this will end up breaking down based on the scale you want to achieve.  Let's say you have $25K to invest and that could pay for 25% down on a $100K rental.  I, personally, would opt for a $100K rental in most situations because you'll get a materially better tenant, likely be in a better area, etc. that all of those $10K-$50K properties.  Since you won't live in the market there's benefit to having something that's not dredging up tenants from the bottom of the barrel.  But, for my example, it really doesn't matter.  

$25K w/ 12% CoC = $3000 per year

$25K w/ 10% CoC = $2500 per year

$25K w/ 8% CoC = $2000 per year

So the "awesome" vs. "horrible" CoC deal is $1,000 per year. That means that your $100K property only has to appreciate 1% more per year than your "depreciating market" in order to break even. Not to mention it breaks down to $83 per month. I had dinner with my wife last week, it cost me more than $83. I'd give up that monthly dinner (if I had to) to own an 8% CoC property that's in a better area instead of a 12% CoC property in a "depreciating market".

What's more, you likely haven't factored in travel costs to your CoC return. Let's say you're pragmatic and want to visit your property twice a year just to keep an eye on it. What's the difference in flight costs if you're going to Utah, Arizona, Idaho, New Mexico, etc. vs. Ohio, Michigan, etc.? I don't know the answer but it certainly isn't "zero".

I'm not saying that seeking out 12% CoC returns is a bad thing. It's not. But it's better for you to establish your investment parameters first rather than using someone else's arbitrary metrics.

Or, to put it another way, you could offer to give me the $10,000 home FOR FREE and I wouldn't take it.  Truth be told, I'm sure I could find homes listed for $50,000 that I wouldn't take (to buy and hold) for free.