5 $150K properties or 20 $32K properties?

[Jon Klaus]

Bill Gulley posted in another thread that he'd rather have "5 150K properties than 20 32K properties, all things considered. Generally, less maintenance, less management efforts, fewer collection problems, less vacancy and better appriciation."

This is from the topic Attracting a Good Tenant. http://www.biggerpockets.com/forums/52/topics/82142-attracting-a-good-tenant

I think this is an intriguing choice. Let's flesh it out a bit and hear your opinions.

Added assumptions:
5 $150k homes that rent for $1600 on average in nice parts of town in mid-America. Homes are owned with no debt. Expenses run 45% of income. You self manage, spending about 100 hours a year of your time. NOI is $52,800.

Or

20 $32K homes that rent for $700 each in not so nice parts of the same city. Expenses run 55% of scheduled income because you have higher vacancy, turnover, and make ready expenses. You self manage, spending 400 hours per year of your time. NOI is $75,600.

Certainly,other assumptions would need to be made, but which portfolio do you like and why? Assume you will hold for the long term.

[David Beard]

Well, in my market, and most metro areas of the midwest, you can certainly get 2%+ a month easily on the $30-35K houses, so I think that's realistic. I'm actually more skeptical of the $150K house that rents for $1,600. Rent yields drop precipitously as prices go over $100K in most places.

Also, regarding expense assumptions on the expensive homes: taxes and insurance will be a much higher percentage of gross rent, so I think this essentially offsets the other issues. Lower end tenants can also be stickier, as they are perennial renters, versus the higher end folks who are likely transitioning to ownership (admittedly, all the middle class folks with short-sale stains on their credit may keep them as renters for longer periods -- so we should like to rent to short-salers?).

As far as maintenance, it should be assumed that the cheaper properties have been updated, are either brick or vinyl/alum clad. A 10 yr old house will have aging roof and mechanicals, so it presents its own issues. Lower end tenants are less demanding, and the home finishes can focus purely on durability, with few amenities.

I know you said self-manage, but many PMs give discounts based on unit volume, so greater units might trigger lower average PM rates.

As far as diversification, there is a sweet spot for how many you own, and it's more than 5 (but less than 20). For stocks, I've seen studies that indicate optimal diversification at around 15-20 companies. One vacancy in your large portfolio of inexpensive homes hardly makes a dent.

A large benefit to the expensive homes relates to financing advantages. You could use your allotted 10 Fannie Mae 30-yr loans to build this portfolio, but could not do so on the more numerous and cheaper houses. Loan closing costs are much more efficient across just 5 loans as well.

Personally, I think the inexpensive homes have the most room to rebound in price over time. Prices on these collapsed the most, as many in the midwest are buying REOs at 25-30% of 2006 prices. The rent/buy ratio is so absurdly skewed, that just some minor mean reversion will generate significant capital appreciation. The $150K houses in the midwest did not fall in price any where near that degree.