What they don't tell you about cheap rental properties

[Marcus Auerbach]

It all sounds so perfect: you can buy a house for cheap, have someone else fix it up for you and then rent it out for great cash flow. You run the numbers (on a BP calculator, they are really good BTW), you read the forums on BP and after moneth of research you are convinced this will work!You can make it work!

So you narrow it down to a city (maybe Milwaukee) and you call an "investor friendly agent" to help you find a great inexpensive property. There are some on Zillow for 5k, so spending 50k or 100k will surely get you a good deal. And you won't have to deal with the tenants, because you will have a PM to do that for you, so problem solved (in theory at least). Some agents tell you that's a bad idea, they probably were not the investor friendly kind, plus most agents don't understand investing (which is true), so you just keep looking until you find one who is happy to write a few low ball offers on cheap properties - and you buy your first one!

Surprise number one is finding contractors is a lotharder than they made it sound in the book! Let alone getting three bids! Contractors are either booked out for the year, or they are expensive, or the worst, not trust worthy. Finally you found one, but when you tell him where the property is, he does not want the job anymore. He is worried about his truck and his tools, not worth it he says.

I have seen a lot of houses over the years that have been "remodeled" remotely and I have seen the "quality" of work that can come without the owner checking in person. Like upper cabinets "secured" by finish nailes, makshift plumbing and electrical, trim and woodwork that looks like a kindergardener has installed it, drywall that shows every single seam, roofs that leak from day one. The best part, it is almost impossible to sell a house like this, even a low income buyer will get scared by the home inspector.

The remodel went over budget, but after 7 months of remodel agony now its time for cash flow and to hire a PM to get the place rented. Turns out not every PM wants to take on your property when you tell them the address. But you finally find one who will do it and has a low enough fee. So you hire them and they place a tenant. Rent starts comming in - finally success!!

So you go ahead and buy a few more of these properties. It is hard work, but you have mastered the first one, you have learned a few things, the next one will go better.

A few years into this and with a hand full of cashflowing properties you start to notice that repairs request start increasing. A new furnace, a ton of plumbing repairs on the 60 year old galvanzed pipes, the PM says they need to fix the ceiling, because the roof (that had a few years left when you bought it) is leaking. You realize that capex is exceeding cash flow.

Meanwhile there are some problems with the tenants. You receive fines from the city (DNS) for littering and trash, the police gets called to deal with issues, one tenant moves out, and the PM can't seem to get a grip on this. No rent for 3 months. You had enough and fire your PM, find a new one. The new guys come with a hole list of expensive repair requests, 15k in total, but they also recommend a few extra things on top of that like a new garage. You decide to make a trip and find the place is trashed. You have never seen anyone living in such a flith. The weeds grow tall, fast food wrappers everywhere. The aluminum siding has dents everyhwere!? Walls are damaged and dirty, someone punched a hole in a beedroom door. There are drawers missing from the kitchen cabinets....!? 

Now you have to deal with an eviction, you try to get money from the tenant for damages. Attorney, small claims court, daily emails and phone calls. Tenant has no money, just fieled for bankrupsy. Meanwhile you are trying to find a contractor, who can get the place ready and an agent to sell it. An investor offers you half of what you paid. You finally get it listed, an offer accepted, home inspection comes back and reviels a whole list of expensive repairs. The elctric panel is not safe and needs to be replaced, a basement wall has a crack and needs to be beamed, probably cause by water from the missing  downspout extensions. Reluctantly you agree to get all these repairs done, more working with contractors, more expenses. But it will soon be over!

A week before closing you get a phone call from your agent. Financing fell apart, because the buyer has lost their job. So back on the market, you just paid the foundation contractor and the electrician an amount that equals about 20% of the list price.

You can see where this is going. I am currently working with a friend of a friend helping him liquidate his small portfolio. I have done this before, it's often more work and frustration to sell a cheap house than one for 200k or 300k (or 600k). He basically went through the experience above, he said he never should have, it was a bad idea. I am not excided about the listings, I can barly cover team expenses, I do it just to help him out.

Last night someone called me, saw me on BP,  is looking to buy investment properties, no experience and never been to Milwaukee, but he heard it's great. Wants to buy two houses every year until he has enough cash flow to retire, hates his job. Tells me the hole plan. Budget is 80k per house. I explain that I have been a buy and hold investor for over a decade, done a lot of BRRRs, worked with a lot of investors. Median home price in Milwaukee is now over 200k, he'll be in a rough neighborhood. That I am personally buying only properties that are at least twice that amount, that's before rehab. It's 2021, prices are up, market is hyper competitive. I am telling him why this is a bad idea. 

He thanks me for my time and asks me if I knew of any more investor friendly agents.... 

True story, food for though.

[Marcus Auerbach]

@Demetrius Lindsey - that makes me happy! It has gotten very hard to buy a good property; Milwaukee has been appreciating every year since 2015 (so much about the old  "Milwaukee is a cash flow market") and investors who hold quality properties have seen their portfolio value increase massivley! 

At the moment the market appreciates about 1% per month and quite frankly there is no end in sight (I talk a lot about this on my YT channel): the city is fully built out, there is no new construction much under 500k and we have about 160,000 millennisals in Milwaukee that are looking to buy a house - in a market that sells about 10,000 homes a year. Until something in this equation changes prices are bound to go up.

Investors who buy higher prices assets have benefited the most. If you hold 5 properties valued 1,000,000 for example (200k a pop) and the market goes up 10% your net worth went up 100k. One your 200k down payment that is 50% ROI. Not to mention you are deleveraging your financing at about 3% a year - that is 3% of the 800k, not the 200k down payment! Meanwhile you may have 10-20k in positive cash flow, which is nice and important to have, but you can see that it get's dwarfed by appreciation and principal pay down. (Yes, I know I have simplified the math here a little and used round numbers to illustrate the mechanics).

Inflation is another factor in this game. Currently at 5.2% the FED thinks (or at least says) it's temporary; we will see. In any case owning a hard asset is the best bet hedge against inflation.

[Account Closed]

I dunno...

I think this is a great discussion/thread. I also think it's not. It's been too general and does not factor in the individual investor very much. Which after doing this for awhile, would say is the most significant element in the equation.

I've been working in the physically distressed areas of Milwaukee. While I would say all the things that have been said are surely pitfalls that can and do happen, I would also say they can all be avoided, and that has nothing to do with the property and everything to do with the investor.

Physically distressed areas have advantages too. They present opportunities that are sometimes over-looked. Limited cash can get in the game. Land is sometimes free. It forces an education in cap ex, which is perhaps the most necessary lesson and at the same time, the most ignored. And then there's the relationship between rents and cost.

As I read these sorts of threads, the ones dealing with what everyone endearingly refers to as the hood (including those who live there), it is always pretty obvious which people actually understand what they are talking about and which people rely on assumptions. I will say this, many of the assumptions are wrong. For instance, the assumption that physically distressed neighborhoods certainly equal a distressed economic status of their residents is not accurate.

The one part of this discussion that I would whole-heartedly agree with is that owning and managing rental property is complex. I think it's a tall order in the first place, and when I see droves of inexperienced and perhaps ill-equipped persons attempting to do it from outside of their own town, I worry they may have jumped in over their heads but again, successful people are successful and maybe that matters not.

For me, I'm getting out. I've done just fine as far as I'm concerned, but have come to some realities within my personal life that render the idea of continuing the endeavor a poor choice, most significantly my age and health, and that is what it is. The biggest mistake I've made in my endeavor is not factoring in my personal life when I started, not my choice of particular property. If anything, my big mistake was not starting when I was 20 and thinking I could start when I was over 40.

The largest rental property owner in Milwaukee owns in the hood. We all know who and where that guy is by his signature landscaping - lol. If owning in the older parts of town is such a terrible idea, how is it the largest owner is there? How is it that his properties are constantly being improved instead of left to rot? Does he know something the rest of us do not? Or will we all see him crash and burn in the future? Or maybe, he's just a rich philanthropist who wants to give away his money by fixing up the older areas...

I dunno...

[Jorge Ruiz]

@Account Closed

Thank you for your input. It's nice to hear another point of view- not just doom and gloom if you want to invest in the hood. 

All the best to you.

[Andrew W.]

"It all sounds so perfect: you can buy a house for cheap, have someone else fix it up for you and then rent it out for great cash flow. You run the numbers (on a BP calculator, they are really good BTW), you read the forums on BP and after moneth of research you are convinced this will work!You can make it work! .... etc. etc..."

A genius post from Marcus - and I know that that it comes from a lot of experience.

[Marcus Auerbach]

I know the author "account closed" very well, he convinced me 5 years ago to help him buy properties in the rougher parts of town and it was the last time I have agreed to do that. It was an experiement for me, I had never done that before, not personally as an investor nor as an agent. He is an exceptional resiliant individual who made it work with a lot of personal effort, time and a huge comittment. But I have also heard his stories over the last five years, the tenant that went crazy, the tenant who tried to sue him for money, the tenant who did not pay rent for a year after he gave her a month free rent as a thank you... He did a great job fixing up his properties, it was the people that caused the stuggles. And yes we have a large investor in Milwaukee who owns the hood (someone has to), but don't ask any details!

[Jill F.]

Originally posted by @Matt M.:

@Theresa Harris

@Marcus Auerbach

I totally agree. I would not buy anything that I wouldn’t live in.

I used to know two landlords that got permits to carry for rent pickup days. Yeah, no thanks.

 Yes. I have people all the time ask me if I have my CCW since I'm a landlord?! I always ask them who they think I'm renting to? Good Lord, I'm not renting to people I'm afraid of. And I NEVER-EVER pick up rent in person. No, No. It's the tenants responsibility to get the rent to me according to the terms of the lease. 

[Matt M.]

@Jill F.

When I rehab my places, I make them nice and like to keep them nice. No pets. And if something were to change in my life, I wouldn’t hesitate to live in any of them. 
I do usually pick up one rent, only because it’s 3/4 mile from my house, on my way home, and always cash. single dad, and it’s just easier for him, I don’t mind and I go right to the bank. Oh, and it’s $1450 on a house I’m all in at $75k complete with rehab 2 years ago. :) 

[Brock Mogensen]

Totally agree with dollars>doors.  At the end of the day its about the cash flow not the amount of units :)

[Chris John]

@Marcus Auerbach

You've nailed my current strategy.  Borrow as much as I can at low, fixed rates and invest in properties with enough cash flow to keep the wheels on (and hopefully put a little in my pocket) for when things inevitably go wrong while aiming for debt retirement and appreciation.  I'm not rooting for inflation, but at least should have an emotional and financial hedge if it comes to stay. 

[Marcus Auerbach]

@Chris John inflation is great for property owners, because it reduces the value of debt the same way it reduces the value of savings. I also widens the wealth gap, which historically has always lead to social unrest sooner or later. So I agree not a great thing to root for, but a huge accelerator to RE investors, the FED says its temporary, we will see.

[Esther Seme]

@Allan Smith Do you have any tips for a new landlord and how to be a good DIY property manager? I will appreciate any feedback, thank you. 

[Marcus Auerbach]

Glad to hear it Demetrius! Quality is much harder to come by, but when you look back 4 months later (or ten years later!!) you'll be happy you did! I have heard too many stories and seen too many things - it's almost painful when someone not local calls me and is aksing for cheap properties. 

And some will tell me: Thanks for your time, I'll find another agent. Oh, man.   

[Scott Johnson]

I walked into a "remodel" and it was complete trash. They laid laminate over soft spots in the subfloor, the appliances were poor quality and the floors were bouncy. Listed it at $165,000.00.

@Alyxandria Welch is a newer investor who can give some insights on house hacking if that new investor wants to connect with someone who's local. She and her husband live on one side of a duplex and rent out the other. They're doing their own property management atm. 

[Chris Bruni]

Good discussion - wish I had responded sooner...

I have had good and bad experiences in distressed parts of communities and agree that it falls on the investor and involvement more than anything.  I am a DIY investor and licensed contractor so enjoy taking on most things myself.  Much more dificult to do and to stay on top of the maintenace demands if you have this mindset and are not local with your investments.  I have several that are up to 2 hours away and, while I do visit them fairly often and know each tenant, I certainly do not get to them as often as the ones that are 30 minutes away or less.  

If you want to manage your own and DIY the maintenance and updates, you can do that in any market - distressed or otherwise.  But being an absentee-owner, the original thread from Marcus will hold true more often than not.

[Jacob Stevenson]

Great post.  We own real estate in family friendly neighborhoods and around universities (college housing).  We also have a small company that does work for a local PM company.  Some of our best work comes from situations like this!  Overgrown yards, cars and tires in yards, backyards with furniture and trash.  Pay us or pay the city, we are much cheaper than the city!  

I think this also applies to wholesalers.  In my area they are coming to me with the worst house in the worst area.  

[Renee Fulcer]

Wow - Nailed it, thanks!  Super well written article

[Marcus Auerbach]

@Chris Bruni - agreed. And to your point, locals know much better what they are getting themselves into. OOS investors often decide by the numbers and seem to think: how bad could it be? One quick visit on a Saturday morning does reviel the full picture, let alone buying sight unseen!

@Jacob Stevenson that goes back to the issue that wholeselling is often viewed as an "easy" way to get started - which leads to the worst house in the worst neighborhood.

[Lynn Milos]

@Marcus Auerbach 

So many good points.  One situation we haven't encountered is where the PM doesn't want to take on the property due to the area, but I can understand it. Definitely heard nightmares where the contractors will not work in certain areas due to being robbed multiple times...either things right out of their truck or from the property itself, despite alarms. Those facts themselves are red flags for me.

[Marcus Auerbach]

@Lynn Milosin reality it's shades of grey: you will eventually find a PM that will take on the job, just like you will eventually find a contractor who will go there, it just may not be the one you wanted. A new PM who has to scale to survive and is willing to go to any lenght to make his start up successful will take the job.

These things always sound good on a conceptual level, but the devil is in the details as they say. You read the book that says get three estimates from contractors, sounds great until you call 5 contractors and they don't even call you back, let alone spend half a day to talk to you about your project, while they should be on a job thats waiting and making money.

[Louis P Lessor]

Thank you for sharing, could not agree more with the below thoughts

1. I have a rule that we don't buy a property we would not feel comfortable living.

2. Listening to people who have been there and done that 

3. Focusing on the numbers - yes numbers are important but if it takes you a year or two more to recoup your money and its a good long term investment then that is the better option instead of the 80k that needs more work. 

[Marcus Auerbach]

Quote from @Mark Brown:

@Marcus Auerbach. I’ve been investing in real estate for 16 or 17 years now and there’s a lot of truth in this post. The numbers can look fantastic on paper but the numbers don’t reflect the human factor. From tenant quality, contractor quality, pm quality, etc. The fact is the best tenants, contractors, and property managers all don’t want to live and work in a slum area. And since they got the capability to live and work elsewhere, that’s exactly what they do.

The only exception to this rule is if you can find a neighborhood that is truly gentrifying. Then the rising tide of prosperity can bring in the better people.

 Hi Mark, that is certainly a factor! We have a housing shortage in Milwaukee like everyone else, but while TX has issued so far 96,000 single family building permits in 2022 (I coincidentally looked it up yesterday for my YouTube market update) we have issued only 6,100 permits. And almost all of them are over 500k and not very affordable. So to Nathaniel's point, we need more Wolf builders here! 

So, what's left? 

The pressure is pointing inwards into the lower cost neighborhoods: some will have to gentrify - the very difficult question is just to predict the direction. I was down on North Ave today to look at a listing and there is a brand new city owned 4 story mixed use new development (8 figures) right next to a $75,000 tax foreclosed commercial property. You can be a Wolf investor and go in, but for many, especially not local, that is risky and somewhat unpredictable. A lot of these buildings have deferred maintenance to the tune of 50k per unit and you are investing that on top of the purchase price hoping that the value will reflect it, so you can refi out of it some time.

[Marcus Auerbach]

Quote from @Lynn Milos:

@Marcus Auerbach 

So many good points.  One situation we haven't encountered is where the PM doesn't want to take on the property due to the area, but I can understand it. Definitely heard nightmares where the contractors will not work in certain areas due to being robbed multiple times...either things right out of their truck or from the property itself, despite alarms. Those facts themselves are red flags for me.

Theft is more common than robbery. Contractors can't leave tools on site: compressor, table saw, nail guns, extension cords, everything needs to be packed up every day and then set up again in the morning. Also can't leave materials or appliances on the job.

[Lisa Wright]

Bingo.  I can't say how many houses i show that were obviously a rental without proper maintenance. 

Busted Windows.  Warped floors. 

The reno'd ones have cabinet that won't open.  Floating floors that pop with you walk.  

Like the owners are letting (or unaware) that the home is falling apart then decide to sell for top dollar.   

[Shannon Bunyard]

Also, Marcus I replied before I read the article.  I hundred percent get the contractor concern- we have the same problem in our area of California.  Good contractors are so hard to come by.  My husband and I are maybe looking to do light work on a property but nothing major. Cosmetic only. Good insight/ thank you so much!

[Sue Gee]

This post is two years old but so relevant today. Glad I found it.
Great post!!