When Low Purchase price doesn't make a great Investment option
In the today's real estate markets, investors are finding an abundance of distressed inventory and in some cases for prices that are 10% of the "replacement" cost of the property.
After quickly glancing at the rents on Craigslist you might be tempted to jump off your chair and go grab a handful of these $10,000 priced 3 Bedroom Single Family houses and setup your passive cash flow machine and roll in the dough. Well, not so fast!
There are several markets in the US that exhibit such behavior, let's pick for example South Chicago where the local economy is plummeting and rising crime rates are pushing small cities into bankruptcy depressing the real estate prices even further. So you set eyes on a great foreclosure listed at $25,000 a quick grab and go 3 Bedroom SFH 1000 sqft in Harvey, IL. You quickly check the rents in the area and see that you can fetch easily $1000-$1200/mo, WOW what a Steal you might think. I should buy the whole block!
Well, it turns out that there are several issues that make this deal go awry extremely fast. First rule of thumb for the novice real estate investor who is looking to build a passive revenue flow is to never buy properties in an area you don't want to live in yourself, no matter what. So you start wondering, ok, so what's the neighborhood like in there? One option, get in your car and do a drive by, see what it looks like or save yourself the time and grab a rent & neighborhood report from [REMOVED]. Let's walk though a real case scenario:
The following property is listed on Zillow for sale:
You also notice the rentals listed across the street for $1k to $1.4k and your heart starts jumping. What you don't know yet, is far worse. Let's take this rental and analyze it:
You examine the estimated rent section and notice the estimated rent to be about what you thought or $1,180/mo. Also the comparables sustain the price as well. First thing that you should be worried is the Renter density of 42% as well as the Vacancy rate of 18%. You want the Renter density to be low in the 25% range and also a vacancy rate under 10%. The two things you observe already spell trouble meaning you might have a long time to fill up that vacancy. Let's move on and assess the trends in the area, you observe from the chart that the rent is pretty much stable for the past 12 months, a good sign definitely.
Next you take a look at "Who lives on the block", another major piece of the puzzle:
While we're not going to make any comments, you will notice there is a strong correlation between Household income and Highest education attained and also you will use this information to correlate the Crime rate available in the next 2 widgets in the report:
You notice an almost four times than nation average in the crime rate, including 10 murders and 9 rapes alone in the past 12 months and also more than double the amount Burglary and Thefts. That can't be good for a city with a population of about 25,000 you think, I don't want to have my property vandalized while it's on the market awaiting for a tenant.
With that in mind you move on to evaluate the quality of the nearby schools, which has a high correlation in your decision:
You definitely notice the school quality is at the bottom of the barrel. This again can't be good.
Putting together all you have learned in last 5 minutes you might decide that even though the price is amazing and you will make a Rent-to-Price rate north of 5%, you will most likely have troubles keeping the property rented even even worse collect rents and securing your property against burglary while vacant.
I hope this helped you putting a line in your due diligence todo list!