Investing in Cheap Real Estate: Is a $30k House Always a Pig?

Well, yes. It’s a pig! But…

And here we go with another installment in my by-now-infamous series dealing with $30,000 houses in the Midwest. I want to add a couple of caveats and some more angles to this conversation, which I hope will shine some additional light on the matter. Here we go.

On the Forums This Week

I was invited to comment in this thread this week. DJ is looking into the “pigs” and wanted some commentary from the BP community, and from me in specific. If you read the link above, you’ll notice that I didn’t flat out tell him not to do it, and if you know anything about me, this should be shocking to you. So, let me take this opportunity to explain.

Why You Should Not Buy Pigs

My issue with pigs is three-fold:

One

The house is cheap for a reason—the economy sucks. If this house was in Sacramento, it’d be worth $1.8 million. So, as a matter of broad strokes, you are buying property that’s going nowhere long term because the location is such.

Two

The house is old, but since there’s no equity appreciation, outing money into CapEx on this location is akin to throwing good money after bad. However, you basically don’t have a choice—if you own this house as a rental, if the furnace fails you have to replace it. You’ll never get that money back on the resale, but you have to do it. All of the cash flow you think you’ll make because the house is cheap you will, for the above reason, give back over time. And while your tenants are indeed paying off the loan, in the end, you end up with a free and clear PIG—congrats!

Three

Tenants aren’t stupid. Tenants want nice things. And good tenants, those who won’t stiff you with a 20% economic loss every year, will likely choose to go somewhere else. So, good luck managing that pig.

On the Other Hand

All of the above are real issues—they are headwinds for sure for us guys in the Midwest. Because there’s very little organic appreciation, we have very thin margin for error. We can’t be lucky—we have to be good.

And with this in mind, it all comes down to two things: Management and Value Add.

I am a huge proponent of buying where you live, at least smaller projects. You simply do not have the spreads to underwrite the costs and the economic losses that are part and parcel with outsourced management. So, if you are in Lima, OH, that’s where you buy, but…

You understand every aspect of your market to pick out only the absolute best deals, and aside for the management, the aspect that makes a deal good is value add. Do not buy anything where you can’t increase value within 4 months, period!

And Then There’s This

The poster in the aforementioned Forum thread indicated that the average home costs $71,500. Since the houses don’t exist in a vacuum, we must. So, let’s say that the most expensive house in his town is $160,000, and the average price is in the low $70,000s. What does this do to the definition of “pig”?

Well, the upper economic bracket in this town lives in the $140,000–$160,000 price range. No one rents there; everyone is owner. Likely, $120,000–$139,000 is the upper class, and still no rentals here. The middle-middle is in the $90,000–$119,000 range, while the lower-middle is in the $70,000–$89,000 range. The lower class of owners are likely in the $45,000–$69,000 range, and anything cheaper is likely almost completely renter-city.

What About the Rents?

The most expensive rental in town is likely $1,200/month; this is an executive suite. The slums go for $325–$450. The entry to decent locations starts at $550–$750. And nicer, newer rentals are probably $750–$950.

Thus:

If my analysis of a town I’ve never been to is accurate to any degree, then I’d say that by buying a house for $30,000 that rents for $650, you are buying a pig in a sense that the location will never appreciate, and in fact you may have to take a loss on the sale, when you are ready to sell. Also, you have to ask yourself whether $650 will be stable and will have enough margin so that you can re-invest into CapEx.

Interestingly, I bet you could buy a house for $60,000 and get $750 of rent. You’d be paying twice the amount and only achieving marginally higher rent. However, you tenant base would likely be a lot more stable, causing your economic losses to compress, and because of the strength of the location relative to a $30,000 pig, you are much more likely to see stable and perhaps growing value.

Conclusion

Buying a rental is like a marriage in that it is a long-term proposition. Make your bed wisely because you’ have to sleep in it for a long time. Who do you want to manage? Do you want to do CapEx on 1920s plumbing, or 1960s?

While a $30,000 house is always a pig, in a location where the range goes up to $600,000, $30,000 means one thing. But in a location where the most affluent family lives in a $160,000 house, $30,000 means something a bit different.

Don’t get me wrong, relative to CapEx, $30,000 is always a pig. But relative to economic losses this may not be the case. Investing is about playing the delta—figure it out…

Investors: It’s your turn to weigh in. What do you think about buying “pigs”?

Leave your comments below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.