Would you buy this?

Question

Call from one of my mailers:

SFH, 3/1.  Sec 8 tenant just signed one year lease agreement. House just passed all inspections. Also Sec 8 just increased rent from $560 to $600/month. Owner said he'd like to sell and get at least 21-22k for it. I, of course, will offer less. Due diligence revealed it sold for 28k in 2008. ARV at least 35k (conservatively)

I'm guessing because it passed inspection, there can't be a ton of rehab. Low-income area but not war-zone.

Figures for end buyer. Here's how I see it:

Purchase: 24k (figuring 21k plus 3k rehab if any, hypothetically)
Rents: $600
Expenses: $300
NOI: $300
$3600/yr NOI
15% cash on cash return

Yes? NO? Am I missing something? (hope not, so I don't look like a complete idiot)

Doug Smith · Answer

Hey Norm!

Glad you posted. You have the chance to avoid what I think would be a big mistake. I've bought numerous properties in the "ghetto" (not war zones). I rehabbed and resold some, flipped some, and held some as rentals. The ones I held as rentals are a huge pain in the butt.

Based on my own experience and the experience of several experienced investors I associate with, here's what's likely to happen with that house should you choose to buy it ...

1. You won't be able to re-sell it for the next 5+ years since the vast majority of buyers in low-income areas have been completely wiped out of the marketplace. They can no longer qualify for most loans. So the ARV is meaningless if you can't sell.

2. The repairs will be MUCH more than $3k. Potentially five times that amount over the next 3 to 5 years. This is due to the incredible amount of deferred maintenance that has likely accumulated over the house's' lifetime.

3. This tenant will be a huge pain ... they may pay on time since their Section 8 money depends upon it, but they'll request all sorts of frivolous repairs and complain about everything. Most tenants in low-income areas fit this mold.

4. Your tenant will leave in a year or two, and you'll have an extremely difficult time finding another good tenant. Potentially months of vacancy. There goes your ROI.

5. Once you find a tenant you think is good, they'll prove to be otherwise. They'll destroy your house and fail to pay rent. You'll end up evicting them.

Bottom line: Rental properties in the ghetto always look good on paper and almost always turn out to be a disaster in real life.

Wholesale all properties on the low end and move on. Hold rentals that are at or slightly below the median value for your area.

Hope that helps!
Doug

Norm Chrostowski · Answer

Yes wholesaling

Doug Smith · Answer

My original impression was that he was considering buying and holding. Norm, was this not the case? I now know that you're wholesaling it.

Michael O. · Answer

I dont think him getting stuck with a lemon is the problem as he is wholesaling it. Right Norm?

Doug Smith · Answer

It's nice to hear a different point of view from Mike. We've obviously had vastly different experiences.

Norm, you asked about deferred maintenance. My opinion is that even though it passed inspection, most of the major systems could quite possibly be teetering on the brink of demise. You'll need to see how old the following items/systems are ... roof, AC (condensor, evaporator coil, and furnace), electrical box, and plumbing (esp. the sewer line). If many of them are near death, you could possibly face a scenario where you shell out $3k per year for several years to replace them.

Sounds like you have a good tenant on your other property, but my experience tells me that won't always be the case.

I've owned 10-12 rentals in the "ghetto" and have had dozens of tenants. My opinions are based on my experience with those properties and those tenants. I've had a very positive experience with rentals that are valued near the median.

Glad to hear you're likely to wholesale it! :-)

Doug

Norm Chrostowski · Answer

Hey Doug,

Rehab and construction is kinda my area of expertise. I've done a SH@T load of it. "Deferred Maintainence", please elaborate?

Also my current rental is in a low-income area. The tenant calls when there's something wrong, or when they need me to pick up the rent. Really, that's about it?

Michael Rossi · Answer

Norm,

I think you already know the answer!  This is a very good deal (as a rental) and I would certainly buy it (assuming all other due diligence checks out).   The numbers are good; it's not in a war-zone; and it has a fresh Section 8 inspection.

That's ridiculous!  I have dozens of low income rentals and they are excellent rentals.  Yes, they require management, but that's the price of operating a rental business.

Mike

Norm Chrostowski · Answer

Yes, Mike, I did already know the answer. Haven't dealt with Sec8 much, so I hoped someone (YOU) would chime in and fill me in on details I might have missed.

This will probably be wholsesaled. I have an end-buyer looking for SFH, and numbers-wise this looks like a great deal. Especially if I can get it for significantly less than asking price.

The heading should have been "If you were an investor, would you buy this"?

Michael Rossi · Answer

Ty is exactly right.  The vast majority of low income renters won't bash holes in the walls or destroy the place.  In fact, only a small minority of renters (of any class) will do that.  To be fair, low income tenants do require more management because the farther down the food chain you go, the more they act like 2 year olds.  However, I'll take a good cash flowing low-income rental over a pretty middle class house that bleeds cash anyday!

Mike

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