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!

[David Krulac]

Geoffrey Murphy you're welcome

Rich Weese there are market niches where section 8 rent may be higher than market rent. But since section 8 inspects before move in and every year there after, crappy places don't cut it and don't pass inspection. Standard HUD/FHA requirements apply, no peeling paint, no cracked glass, railings on all stairs inside or out more than 2 steps, smoke detectors on all levels including basement and attic, etc.

[David Krulac]

Steve Babiak

Most of the section 8 tenants that i have had have had full time jobs, one worked for the state, but had a entry level position and 2 kids. Another was a practical nurse, studying for RN and working full time with 2 kids. Another S-8 tenant that I had was an elderly disabled single person with no kids living at home.

[Rich Weese]

David – what I was mentioning and surprised with was how a porch, or a dining room, could be converted into a bedroom to receive more section 8 funds. If I remember correctly it only had to be 80 ft.². I was aware that it had to pass inspection, but these homes were really old and in my opinion pieces of junk but a fresh coat of paint and repairing a couple Windows is very inexpensive in exchange for moving from a three-bedroom to a four bedroom subsidy. Rich

[Geoffrey Murphy]

Thanks for the posts...digesting everything as we speak.

GM

[Callum K.]

I am not sure I agree that "A" properties are low margin. I have multiple rentals that rent for $1500 - $2400/mo and they have provided fantastic returns for me. I haven't seen anyone on this thread investing in rentals at this level, and frankly it has been a gold mine for me, for many reasons. In order to achieve the results in this niche, I agree that you must borrow to maximize returns.

First, stricter lending requirements have isolated many people who have the job stability and income requirements but cannot buy a home because of lots of different reasons including exorbitant medical bills, high levels of expenses (car payments, credit cards), inability to document income sources (1099's and commission-based compensation), job relocation, bankruptcy, not enough money for the down payment, etc. The list goes on and on. For those of us who have been able to borrow and have the money to put the 20%-25% down payment, it has been fantastic.

Secondly, there are a lot of people out there who don't want the hassle of owning their own home. I have been approached by doctors, lawyers, business owners all looking to have a home that they can simply call a landlord to resolve rather than them having to mess with it. I certainly realize this is not representative for all higher income individuals, but lets not forget that there is a market out there.

Third, is the investor pool. This thread alone proves my point in that the supply side of higher income properties is minimal. I have had relocation service reps contact me asking me about my properties because they have clients looking to rent because they relocate their personnel every 5 years and there are just no homes of this type for rent. One of my rentals did exactly that and because his job moves him every 5-7 years, he will not own a home until he retires. He was willing to sign a 5 year lease but I kept it at 2 for starters. My ROI on this commitment alone has already paid back my entire investment, and no I am not even accounting for home appreciation and unrealized gains. My only competition are distressed owners who can't afford to sell the home and are forced to rent it out for an amount comparable to their mortgage payment. Landlords in financial distress is great competition because they are positioning themselves for even more risk if a large expense hits them. Many of the owners I speak with are out in a couple of years. Landlording to them is an opportunity to buy some time, not a solution to make money.

Personally, just because everyone else sees no value in a niche, doesn't mean there's no value. Perhaps they have not been able to identify a model that will work in that environment. Given current legislation, I recognize my model will cap out at 10 properties (per FMNA), but 10 properties for me earning $2000/mo is good money, especially as I begin to pay the homes off. I am sure there will be curve balls at my existing model, but for now, I am okay with everyone else focusing on the highly competitive <$1500 rentals.

[Josh Rowley]

Callum, what is the price point you are paying to get the 1500-2400/math in rent?

[Callum K.]

Josh Rowley They are ranging between $160,000 and $230,000 homes. It all depends on the financing though. These homes I bought from distressed sellers or were homes I rented out after living there for several years. I have been shooting for at least 1% of the sales price for monthly rent and trying to acquire equity on the front end to protect the investment. I must say, its been easier to do over the past few years due to a growing RE market, but they are producing returns I can't complain about

[Mark Forest]

I have found that the one higher end property I have consumes more of my time fixing things like dishwashers, ceiling fans, ice makers, etc. For my “lower” end rentals the first thing I do is strip all that stuff out of there, and paint it all parchment white.

My wife says the best rentals we have are just "little boxes."

[Geoffrey Murphy]

Callum K.- seems that you have a really nice niche going on. I must admit. I really take my hat off to you, especially if your able to put down 20-25% on those price range of investments. Great job

[James Park]

Callum K,

Thanks for posting and i am in complete agreement with your niche and glad to find a fellow bp poster who thinks this way.

My lowest rent is $1595 and highest rent is $3000 range. I concentrate my focus on emerging real estate markets in the high end subdivisions in the northside Atlanta. The high schools clusters I invest in must be ranked in top 10 in the state of Georgia and i concentrate on SFRs less than 5 years old.

My goal is to reach a fixed 30 year mortgage loan of $2 million by 2015 and my end game is to own all my SFRs free and clear for a $200,000 passive income. One guy in biggerpockets who is much closer in reaching my end goal is Robert Steele. He has been very generous with his advice and guidance of how he got to where is he is.

He also concentrates on $200k range properties in the nicer subdivisions in northern Dallas. He is already there with 10 SFRs and now focusing on eliminating the debt service one house at a time to build his passive income for live.

I love this passage from the book, building wealth one house at a time.

"The surest way to become a millionaire with real estate is to borrow a million dollars, buy property, and then pay it off. Even if the property never appreciates, you will have your million dollars.

The key to sleeping well while you are in debt is knowing that you can repay the debt. When you buy rental houses, your tenants will repay your debt if you buy and finance wisely.

author: John W Schaub.

The median household income according to the IRS in 2009 is slightly above $50,000. If your passive income from his/her investment portfolio is double that number or more, I consider that person to be rich.

Originally posted by Callum K.:

I am not sure I agree that "A" properties are low margin. I have multiple rentals that rent for $1500 - $2400/mo and they have provided fantastic returns for me. I haven't seen anyone on this thread investing in rentals at this level, and frankly it has been a gold mine for me, for many reasons. In order to achieve the results in this niche, I agree that you must borrow to maximize returns.

First, stricter lending requirements have isolated many people who have the job stability and income requirements but cannot buy a home because of lots of different reasons including exorbitant medical bills, high levels of expenses (car payments, credit cards), inability to document income sources (1099's and commission-based compensation), job relocation, bankruptcy, not enough money for the down payment, etc. The list goes on and on. For those of us who have been able to borrow and have the money to put the 20%-25% down payment, it has been fantastic.

Secondly, there are a lot of people out there who don't want the hassle of owning their own home. I have been approached by doctors, lawyers, business owners all looking to have a home that they can simply call a landlord to resolve rather than them having to mess with it. I certainly realize this is not representative for all higher income individuals, but lets not forget that there is a market out there.

Third, is the investor pool. This thread alone proves my point in that the supply side of higher income properties is minimal. I have had relocation service reps contact me asking me about my properties because they have clients looking to rent because they relocate their personnel every 5 years and there are just no homes of this type for rent. One of my rentals did exactly that and because his job moves him every 5-7 years, he will not own a home until he retires. He was willing to sign a 5 year lease but I kept it at 2 for starters. My ROI on this commitment alone has already paid back my entire investment, and no I am not even accounting for home appreciation and unrealized gains. My only competition are distressed owners who can't afford to sell the home and are forced to rent it out for an amount comparable to their mortgage payment. Landlords in financial distress is great competition because they are positioning themselves for even more risk if a large expense hits them. Many of the owners I speak with are out in a couple of years. Landlording to them is an opportunity to buy some time, not a solution to make money.

Personally, just because everyone else sees no value in a niche, doesn't mean there's no value. Perhaps they have not been able to identify a model that will work in that environment. Given current legislation, I recognize my model will cap out at 10 properties (per FMNA), but 10 properties for me earning $2000/mo is good money, especially as I begin to pay the homes off. I am sure there will be curve balls at my existing model, but for now, I am okay with everyone else focusing on the highly competitive <$1500 rentals.

[Matt Stoker]

James,

I agree with your thoughts. I have been doing the same in Salt Lake City. While I have only been able to acquire 4 homes, I see this as a "fool-proof" way of building wealth. I want to be the old man driving his 59 El Camino showing up to collect my rent on the first of each month. They can hear me coming from the rumble of my big block.

[Sean Stewart]

James, great post! I loved "building wealth one house at a time". It was my first real estate book and I think its the best primer/get-you-excited book for anyone new to real estate.

I am a new investor in the D.C. area where you have the full range of ultra expensive housing and projects. Although I do not know exactly where yet, my plan will be to start with lower end rentals (not warzones) and eventually sell off the ones that cause the most trouble to buy higher income rentals. However, If the cashflow works and I'm finding that it is not overwhelming to manage the lower income properties, I could see staying in that market forever.

This is a great thread that really got me thinking about where I want to be. I especially like the idea of finding hardworking blue collar workers as tenants.

[Mike McKinzie]

James
I am not sure if you mean $200,000 a month or $200,000 a year? While I am no where near the first number, I am past the second number. And as to the question, I have a good mixture of both but prefer the slightly higher end. My rents range from $600 to $2,200 a month.

There are several factors that go into making an investment decision. And one of them is what comfort level you desire with the houses you own. My dad used to say, "Every house you drive by is owned by someone," meaning if it is tenant occupied, some investor is collecting the rent (sans trespassing).

There are a lot of homes in the $50,000 range that rent from $700 to $1,000 a month. I own a handful of them, almost all of them are on Section 8. While not my preferred type of investment, it is hard to argue against collecting 1.5% to 2.0% of the houses value in monthly rent. The down side is the lower chance of appreciation. Good property managers take care of the rest of the potential problems.

On the other hand, homes in the $200,000 range usually rent for less than 1% of their value.

Thus, my comfort range is the $100,000 to $150,000 range that rent for from 0.9% to 1.4% of their value. Newer homes, in desirable areas, that appeal to the strong middle class are the homes in my comfort zone. Six of my last seven purchases fall into that category.

So, have an open mind, good RE deals come in all price ranges.

[Eric Hettena]

Wow, this is some serious information you all provided. Thank you all who participated. I really appreciate all the ideas and strategies behind low end and high end rental properties.

Also, thank you to Geoffrey Murphy for putting this thread together and keeping it moving.

[Ali Boone]

I just wrote a blog on here about just this topic. I prefer the lower cap rates any day over the higher ones! People are so quick to only want the higher cap rates (on paper) that they don't see what vacancies and repairs do to those returns. They totally sink them. I know this firsthand. Feel free to check out my article in the blog section called Battle of the Cap Rates. Emphasizes what a lot of people have responded with here.

[Dawn Anastasi]

The last rental I did I purchased for $24K and put $15K into it for an investment of $39K and am getting $1100/month. (Not Section 8). I would love to do more of those!

[Chris Clothier]

Originally posted by Ali Boone:

I just wrote a blog on here about just this topic. I prefer the lower cap rates any day over the higher ones! People are so quick to only want the higher cap rates (on paper) that they don't see what vacancies and repairs do to those returns. They totally sink them. I know this firsthand. Feel free to check out my article in the blog section called Battle of the Cap Rates. Emphasizes what a lot of people have responded with here.

Ali -

I loved your article and it is so true. Some investors will always chase a higher return and will be willing to take on more risk. Unfortunately, some of that risk can be VERY RISKY and lead to a much lower return when you are talking about SFR. These are not like triple net leases - these are single family homes and there are only a few ways to push a return up and most are not good for the final investor.

[Chris Clothier]

Originally posted by Dawn A.:

The last rental I did I purchased for $24K and put $15K into it for an investment of $39K and am getting $1100/month. (Not Section 8). I would love to do more of those!

Dawn - That is an exceptionally good investment by you. Hopefully it continues to perform just like that into the future. Even if it settles in a little after year 3 or 4, it should still provide a great return.