lower end rentals vs higher end rentals

[Geoffrey Murphy]

Hey BP,
I have a question that has been on my mind for sometime now. I was reading a few threads from the archivsection on this but i still needed a little bit of clarification.

I notice that some investors invest in low end rentals (c neighborhoods) vs high end reantals (B to A neighborhoods) U

How do ypu guys make money in the low end rentals. I mean, i was always told to buy property that were locatd in a good area where veryone wants to live, that way the unit is easier to rent or easier to sell in case something came. But i hear investors all the time that the low end stuff givess of more cashflow ect...

Why is that? How do you get that to happen? I thought these tenants were the ones we didnt want?

If someone could explain WHY and HOW? I would greatly appreciate it!

[Don Konipol]

I built my wealth with lower end rentals - actually mostly in commercial real estate. Now that I am preserving my wealth to a greater degree than building it, I invest only in very high end properties.

Here is my take for what its worth - investing in lower end real estate is a business - investing in higher end real estate is an investment.

The difference is the amount of active participation required of the owner and the intensity of that participation. On lower end properties I obtained returns of 15 - 25% annually. Higher end is lucking to get 7.5% cap plus hopefully cash flow.

It's much easier and quicker to built wealth on the low end, but requires more time, skill, experience and involvement.

[Nathan Emmert]

Originally posted by Geoffrey Murphy:

We all know that there are different kinds of low end areas and higher end areas.

Lower end, which area would you choose to invest in? or what do you want to see in a lower end area/Higher end area?

ex: lower end, war zone?, Section 8? ect

Higher end, newer properties? certian income?

I choose working class areas. Areas that provide stable low end (hourly) employment and where tenants aren't going anywhere. They can't afford to relocate and honestly most aren't even thinking about buying homes. Good, honest people trying to make ends meet looking for a safe, maintained, healthy place to live.

I don't have the headaches of Section 8 and the scum of the earth (apologies to slugs)... and I don't have to deal with finicky high end people just waiting to buy a house. Good reliable tenants that will stick around. That's what I want.

[Joel Owens]

"I built my wealth with lower end rentals - actually mostly in commercial real estate."

Don I would love to hear you post more on this and how you did it.

As for the rentals even in an "A" area you can have pockets of working class tenants in older buildings.

Example: You have an "A" area where incomes are high and shops are fancy.The higher income homes have to have people work the lower paying jobs in the area to serve the higher income people.

So you will have developments with older apartments where normal rent is 1,200 but these tenants pay 800 in older buildings to be in the area where they work but cannot afford to go to most of the places there.

So an "A" location isn't a guarantee of not having any problems.Screening the tenant is critical.I find when you buy to calculate having the best product at the lowest to middle part of the rent range.This creates a ton of applicants and you can choose the best one able to put down the most security.

If you have a good to so-so product trying to get higher rent because you purchased wrong then you will be in trouble because the only tenants wanting to pay higher rent for a mediocre product are generally professional tenants.

I stay away from the war zones.

[Rich Weese]

I really enjoyed the method that Ryan B is using in his real estate purchases. That makes great sense to me and is actually the same type of program that I have been using on of spoken of before.

I'm not sure the terminology that were using is the best that we might find- lower end rentals and higher-end rentals. The numbers are going to change depending on the area you're in as to what constitutes a lower end rental and what constitutes a higher-end rental. Let me give you an example.

I'm going to use my single-family residences I own in Texas of which the majority are in southern Texas. The lowest rent I have is $700 per month and the highest is $1650 per month. I don't consider the lower and as the scum of Earth or slugs and I also don't consider the highest rent as being a trophy property.

The majority of my rents fall in between $940 and $1200. I have not found the problem that Jeff has found. I don't have very many of my tenants moving out quickly to go and buy a home. The majority of them have lost a home or have been hurt by the economy and won't be able to qualify for a home for years. Those are great tenants in my opinion. They are familiar with taking care of a property and they will probably be around for a long time. I also don't mind renters at either end of the spectrum.

I posted in the hyperinflation thread earlier this morning and pointed out that I really do believe there are tremendous benefits in investing in both types of properties. I do try to make sure that the nicer properties which I intend to keep will be free and clear as soon as possible. They are kept in a separate entity from the lesser quality properties which will be mortgaged at an extremely high loan to value ratio. This is kind of like what Ryan B does but mine is like a 202 class compared to a 101 class in college.

I do not buy trophy properties to use his rentals but I also don't buy at the extreme other end of the spectrum. Rich

[Gene Hacker]

Originally posted by Geoffrey Murphy:

Lower end, which area would you choose to invest in? or what do you want to see in a lower end area/Higher end area?

ex: lower end, war zone?, Section 8? ect

I stay out of war zones. I have a very sophisticated formula for figuring out if a property is a a war-zone or not....

Drive by several times, at different times of the day and evening.

Then ask yourself two questions...

1 - would I feel safe walking down the street alone at night.
2 - would grandma feel safe walking down the street alone during the day.

If the answer to either question is no...I pass.

[Jeff S.]

Just noticed my area declined 4% year over year. Question: if higher end properties tend to appreciate more and all properties are declining, what are low end properties doing. Is there a flip flop or are the low end really going down?

[Aly W.]

I have 2 SFRs in low end areas. My first tenants in those properties were on rental assistance, and were very high maintenance. I thought guaranteed rent meant no headaches. Ha! One was a great housekeeper but had an entitlement attitude not to be believed. The other never asked for anything but got kicked out of the program and caused a lot of damage to the house. The third, and last, on rental assistance was moderately demanding and caused some damage by being a slob.

Since then, the new tenants in both properties have decent jobs, have families, and are in no position, now or in the near future, to buy homes. They take good are of the houses, have actually made improvements, only call me when needed, and pay their bills. These properties will likely never appreciate.

I have 4 condos in very solid middle class/family areas and all the tenants have good jobs and also will not likely be buying homes in the near future. These units will definitely appreciate.

My feeling is not to avoid an area per se, but a class of renters. I will avoid rental assisted tenants to the extent I can, if there are market rate tenants equally qualified, they'll get the property.

[McKellar Newsom]

I started out flipping properties and putting the profits in rentals with 550-800 rent ranges. My toughest property is my lowest end property, a duplex with 450 rents.

Recently, I have been upgrading to nicer working class neighborhoods with lots of trucks and less crime. I like the 800-1200 rent range which have fewer turns and maintenance issues. I've been able to buy more equity with the medium end properties. mck

[Johann Jells]

This thread would be much more informative if people would include the GRM of the described properties. Just the rents mean nothing if you don't know what the place cost.

By the standard of this thread we invest in b-c areas, even though we pay $80-90k per unit in multis, that rent $1000-1300, I can't imagine buying a home for under $50k, never mind under $30k. But we believe the area will be the next one to gentrify (our 1st property in 97 did VERY well in that regard), and we rent to young educated people priced out of that kind of space in better areas.

[Geoffrey Murphy]

Thanks for the great tip!

[Jennifer Lee]

Wow great thread definitely learnt something new today
Thanks for taking the time

[Amie D.]

I have done a sort of combination of both - buy in lower end areas that are on the verge of coming up in value. I don't look for the "up and coming areas" where competition is already heating up, I look for the areas that will be "up and coming" after that. I did that with my first house in CA, sold a couple years later after a mall came in and made a great deal from that. Then, bought my rental in a borderline area of a college town which was on the verge of redevelopment and now it has appreciated quite a bit, yearly rent raises and the clientele is a lot better.

My next house like that is on the low end now but in a few years is expected to come up in value due to the proximity to the downtown area, which is being heavily redeveloped.

If I had my say I'd prefer higher end due to less risk of skipped payments or damage, but buying in this way has suited me well. Low end areas that are in further decline get a pass from me.

[James Vermillion]

I just purchased my first rental property and am looking to buy another one in the same area. I chose the area because it is a great "middle" area where I will have a lot of qualified tenants to chose from, who are likely to stay for a while, but without a lot of the issues that come from lower end areas. Sure, I do not "cash flow" as much as I could if I bought in other parts of town, but I purchased in an area I am comfortable in, feel good about the long-term prospects, and will be able to manage much more easily.

I have done some analysis and seen some "returns" on investments in some lower end areas and feel they are often phantom returns, as many things are often not accounted for in calculations.

In the end though, there are ways to make money in both types of investments, it just depends on your goals, your strategy and your level of involvement.

[Geoffrey Murphy]

James Vermillion- great job...i can definitely say that you have given me some really good advice before.

Care to share the details?

It looks like higher end rentals, is defnitely where everyone wants to be...

[George Paiva]

My take from all this is to stay away from either end of the spectrum (class A or D locations). The outliers, in the statistics world we ignore these.

Class A - Slim profit, hope for Appreciation bump.
Class D - High COCR, but you need to keep repair/maintenance/vacancy at bay.

I think its safe to say most folks here have a slight advantage over many who buy a property and hope for the best. We all know how to analyze and perform due diligence and minimize risk. Each location or property type has its own way of making money as long as we are smart enough to realize how they align to our goals.

So this leaves us middle class and working class properties that attract those classes of people. This is the sweet spot IMO. As long as we "landlords" manage these properties like a business we will all be ok.

My personal desire is to buy B/C property in B/C locations with a focus on population and employment upward trends. For the folks in the Northeast like myself it will be a tough strategy but its out there just harder to find.

Its great to have a forum like this where we can all learn from each other and make us better "investors" in the long run.

[Pat L.]

Originally posted by Mike H.:

This was a great thread for seeing the list of pros and cons for the
investing in the diff area types.
I will say I was a bit envious seeing the one post that
was getting houses for 40-50k "all in" that were renting for
1300-1500.

Thats crazy cash flow there. Based on my math, your payments are about $250 to $300 and I'm guessing taxes and insurance might be another $300 or $400 (assuming the assessments are still pegged to boom prices as most counties here are still at).

That still leaves cash flow at $600 to 800 per month assuming no money down.

For that kind of cash flow, I would pick up the rent every month from my tenants as well. Wow! I'm not sure that even qualifies as investing anymore at those numbers. I would consider that somewhere along the lines of winning the lottery.

I don't do conventional rentals only LTO, but I love the low end market.
here's one example ....
We paid cash for a nondescript VA foreclosure (duplex) for $14,500 spent $4,200 on low end rehab (bathrooms/kitchens stripped to the studs). (You would be amazed at what people will live in).
Sold it LTO for $38,500 @ 14% over 13 years with $3,500 option money down
(calculate that return). The duplex unit income accelerates the pay off. They get to see full equity home ownership in 10-13 yrs not 25-30yrs.
They also pay an annual adjusting escrow/mo to cover taxes, insurance utilities etc. He has 3 years left of the 13yrs & we are already looking for another deal for him to get into.
The entire time he has been his own (very tough) landlord & maintenance guy & direct deposits faithfully every month.

He was originally living in a trailer park paying $475/mo lot rent & a $600/mo loan on a barely liveable single-wide. Initially he balked at my % rate but when I showed him what he would pay just in lot fees over the same period of time he signed on.
I find the same thing for those just subsisting on a minimum wage & paying rent. You can get them into low end duplex ownership for less than rent along with some added income. It's a great concept & over the last 25 years that we have been doing it very few default.

[Serge S.]

I believe the best formula is to invest in both. Use leverage to buy the better homes $70k-$100k for rents of $1200-$1500 obviously depending on you market. Take down as many of those as possible with debt and when you can borrow no more move into the $30k-$40k lower end with rents of $600-$800. There are good and bad tenants in both classes but having done this I would say higher end is better in most aspects. If financing were not an issue I would focus solely on the sweet spot of $70k-$100k homes. Unfortunately in my market those deals no longer exist. Every market is different and I would be less cautious about defining a strategy of type of investment but rather focus on the best possible ROI in all types. Take the best deal that the market will give you at the time. This means being flexible and changing with the market. I firmly believe this to be the key to success in this game.

[Geoffrey Murphy]

Serge S.- you sounded like my mentor for a second. He always says be ready for change, and take what the market gives you...

But after reading through this amazing thread, i would definitely start to say invest in both classes...

Any more thoughts BP, were rocking!!!

[David Krulac]

Geoffrey Murphy

You have to define exactly what is A, B, C, D. Here's how I would do this... I'd look at the HUD rents for all areas of the country at www.huduser.org

Im my area for 2013 the section 8 rent is $1,160. This is the average rent as determined by the HUD rent survey. And it is also the MAX that HUD will pay for section 8 rent. So if that's the middle rent then I'd consider that to be C+/B-

I'd say that the B rents would be about $1,100 to about $1,400. Above $1,400 would be A rent. Below $1,100 to $850 would be C rent. Below $850 is D rent. These are only my approximations for my area. Your mileage will vary.

For me the best spot is the B & C+. Once you get into A class, the tenants are very fussy, they're paying a lot of rent and they expect lots of service/amenities. And often times the A renters can afford to buy, and sometimes are short termers, maybe between purchases or building a new home.

[Rich Weese]

Hi David,
I looked up the website for a couple of counties that I have rentals in. It showed a number for a three-bedroom home and also a four bedroom home. If the amount for a four bedroom home was $1452, does that represent the maximum amount that HUD will pay? If the rent is higher than that, is the renter allowed to pay any portion above that amount? I have not rented to section 8 people, but it looks like the government is throwing money around in this arena also. Rich

[David Krulac]

Rich Weese

The dollar figures on the HUD website are the MAXIMUM allowable rent. Each local office can vary their application of the rules, so different areas may have slightly different rules. But in my area that is the max rent and they do NOT allow the tenant to pay more rent. The idea being that they don;t want the tenant committing for more rent than they can pay and getting in over their head. There are other rules that affect the amount of the rent like that the tenant can pay no more than 40% of their income to rent.

If the rent allowed was $1,000 a month and the tenants income was $1,000 a month, that doesn't mean the tenant pays $400 and section 8 pays $600. First they figure out what the section 8 portion will be. And lets say that is $500. The tenants portion can be no more than $400, so the max rent would be $900, not the $1,000 max. So the actual rent allowed would be less than the max rent.

Another limiting factor has been the economy and the effect that it has had on the waiting list for section 8 rent assistance. In the years a long time ago, like before 2008, when the housing and the economy were better, things were a little different than now. A certain percentage of people would get off the section 8 list every year. Some would move, some would marry, some would get better jobs and more income and be disqualified. In some section 8 offices this might have been as high as 25% every year. Since the funding that the section 8 office gets locally is limited, the fall out rate would open up essentially 25% slots every year for new section 8 candidates to get rent assistance. With the slowing of the economy, these fall out figures dropped significantly as fewer and fewer people were staying on the section 8 active rent assistance list. Waiting lists grew and the only way to get new rent section 8 money was for somebody else to get off rent assistance.

Some local offices had waiting lists that were several years long and getting longer. Some local offices shut down their waiting list and were accepting no more new applications. So it has been harder to get on section 8 today that it was in years past.

Most of my rentals are at a higher rent than the section 8 max, which essentially rules them out as section 8 rentals. When i do have a vacancy that meets their max criteria, I'll put in the ad "Section 8 OK", which causes the phone to ring/emails to fly.

The max rent is determined by an actual rent survey conducted by the local section 8 office every year. I've participated in the survey for many years. They ask for addresses of rental properties and what is the actual rent and bedrooms for that property. By this they determine the actual fair market rent, and since the results are published at www.huduser.org, it is available to the public, so you can see was the average fair market rent is in your area, so you can use that information in your rental business.

For 2013, in my area the rent rose, but in the previous couple of years, the average rent went down. I questioned that at my local office, since I knew I wasn't lowering rents. I was told that some large complexes were actually lowering rent to fill vacancy, and that lowered the average and lowered the amount that section 8 would pay to ALL landlords.

[Rich Weese]

Thanks David. I thought it varied by zip code?? I knew someone in the Tampa area buying old crap houses, enclosing porch (for example) to make it 4 bedroom and was receiving well over $1000. This was 3-4 years ago. He was a BP member, but haven't seen him lately. Maybe hes around and will chime in. Rich

[David Krulac]

Rich Weese

Different areas have different set ups. In my county the section 8 office covers 2 entire counties. In a neighboring county there is one agency for the urban area and another for the area outside of the city.

In more rural areas the office covers more area, in urban areas less areas.

[Geoffrey Murphy]

David Krulac- thanks alot for the webiste. i defintely can use it towwards my arsenal. Im actually pre-approved at the moment, and im currently searching for the best possible deal that fits my criteria (3-4 family) and this site will definitely used for my due dilligence...

Thanks alot David

[Steve Babiak]

Originally posted by David Krulac:

...

The dollar figures on the HUD website are the MAXIMUM allowable rent. Each local office can vary their application of the rules, so different areas may have slightly different rules. But in my area that is the max rent and they do NOT allow the tenant to pay more rent. The idea being that they don;t want the tenant committing for more rent than they can pay and getting in over their head. There are other rules that affect the amount of the rent like that the tenant can pay no more than 40% of their income to rent.

If the rent allowed was $1,000 a month and the tenants income was $1,000 a month, that doesn't mean the tenant pays $400 and section 8 pays $600. First they figure out what the section 8 portion will be. And lets say that is $500. The tenants portion can be no more than $400, so the max rent would be $900, not the $1,000 max. So the actual rent allowed would be less than the max rent.

...

One other rule that comes into play with Section 8 is that the tenant must pay 30% of their income toward the rent. So in David Krulac's example, with a tenant having $1000 a month of income, the first $300 toward the rent comes from the tenant. The 40% is the maximum that the tenant can contribute toward rent, so the tenant might be allowed to pay up to $400 toward the rent.

Some landlords I have spoken to only want Section 8 tenants who are on welfare - little to no income to count, so the whole rent amount is guaranteed to come from the gov't.