In areas of low appreciation, what financial analysis figures are your minimums?

Question

I'm south of Pittsburgh and investing here in Washington county in SFH for LTRs.  The area does not appreciate well so I have to make sure my financials make sense.  When analyzing deals in a low appreciating area, what are the minimum numbers you are looking for?

Marcus Auerbach · Answer

Don't invest there. Without appreciation you can't make the numbers work. Most houses need a full rehab every 30-40 years, without appreciation you only have cash flow to pay for that. Roof, windows, kitchen, bathroom, flooring..

Appreciation is the largest contributor to your financial success. You need at least 3% and that's below the long term historic averages. Run some numbers on the BP calculator and look where your profit is comming from after 10, 20 and 30 years. That's like ordering a steak dinner minus the steak. That's just salad and mashed potatos.

Disclaimer: appreciation is never guearanteed, you can't bank on it on a year by year basis, but over long periods of time real estate has always appreciated - it has to, at least at the rate of inflation.

I host lunch & learns for our local Rental Property Association and on the topic of how to make a million in RE a question came from an investor who has been in the game for 30 years. My point was that even with very, very coservative assumptions and a modest W2 you can very reasonable generate a million over 10 years with buy and hold - try it with the BP claculator.

So this investor bought low income housing in one of Milwaukee's worst neighborhoods over 30 years ago, he has been working his butt off, does all the handyman work himself, is 65 now and says he has nothing to show for. While we have seen prices almost double over the last ten years, his properties have not. And most of them need a lot of work, he actually refinanced a few just to pay for roofs. It was eye opening for me to walk through his numbers!

So don't do what he did! Find an area you can expect to appreciates at least on an average rate (nothing speculative!) and buy quality real estate, not cheap stuff just because it's cheap and nobody else wanted it.

Jamie Dietz · Answer

In markets that historically do not naturally appreciate you may want ask yourselves if can you "Create" appreciation.  In other words, can you easily create equity with renovations, clean up or increase rent.  I wouldn't recommend big renovations in low cost markets but if you can solve a problem quickly to increase the value then perhaps you don't need market appreciation.   Of course, the best way to create value is to negotiate better price and terms.

Eric Gerakos · Answer

This should be required reading for new investors. There is way too much talk on BP about buying “affordable” houses in Ohio. You end up with a crappy house in a crappy neighborhood with a crappy tenant who can’t pay the rent. Buy in a better neighborhood and you will make a lot more money.

Leo R. · Answer

I'm personally familiar with your area (I lived in Pittsburgh and Morgantown for years, drove through Washington Co countless times).

Personally, I wouldn't invest in Washington Co--as you mentioned, the appreciation is not good, and the headaches that come with C and D class areas are not worth any amount of cashflow to me.

A while ago, someone pitched me a property in that area, so I had my agent on the ground check out the property and run some analyses. The cashflow and CoC return were both phenomenal. The house was a new rehab--new everything.  BUT, it was in a D class area. I turned it down.

A while later, I learned that another investor bought it, tenants moved in, and the cops were called to the property five times in the first two months for various tenant-caused problems (domestic disturbances, alleged drug dealing, trash being left on a neighbor's property, etc.). According to my agent who knew the investor, the tenants stopped paying rent around the third month. Six months later, the house had burned to the ground, and my agent said it had likely been set on fire by the tenants.

My time is WAY too valuable to deal with those types of problems.

Chasing cashflow in bad markets is probably one of the main traps new investors fall into--read the forums and you'll find countless stories of new investors buying in C and D areas because "the cashflow was excellent", and within six months they're at their wits end with non-paying tenants, police getting called to the property, property damage, MIA property managers, etc., etc.

I'd suggest other strategies, like house hacking and/or buying in markets with better appreciation and a better tenant pool (personally, I've found that doctoral students and medical students often make excellent tenants, assuming that your rent is in-line with their relatively low pay). Doctoral students are typically pretty organized, mature, professional, and they have a lot to lose (so they're relatively unlikely to do stupid stuff like risking their credit and reputation over nonpayment of rent).

Good luck out there!

Robert Ellis · Answer

I think more of the issues in ohio is buying OLD houses from 1920 or earlier with deferred maintenance. It comes from a lack of knowledge about construction, house upkeep, deferred maintenance, etc. It has nothing to do with the market, the market rent. Just because real estate is cheap doesn't make it bad and just because it is old doesn't make it back. You need a knowledgeable agent, construction manager, inspector, etc or someone analyzing the properties as you are going in. Buying below replacement / rebuild cost is one of the main strategies we recommend in columbus / central ohio to our clients but navigating the budgets, properties, etc is a case by case basis.

In areas of low appreciation, what financial analysis figures are your minimums?

Most Popular Reply