Why Buying Cheaper May Come with a Hidden Price Tag

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I’ve been travelling and speaking for the last week and was reminded of a very important principle during my travels. I openly admit that when it comes to travelling, I like to find bargains on hotels, cars, etc. On this most recent trip I booked my rental car through one of the travel discount sites that allow you to select the provider based on comparative pricing across the different brands.  Never one to shy away from good pricing, I selected the lowest priced rental car provider in hopes of saving a few bucks. Of course, last Friday when I was dropped off by the shuttle to pick up the car, I immediately regretted my decision to rent from this company. Not only did the line take over an hour, the car I was given was scratched up and in less than stellar condition.

As I stood in line contemplating my decision to save an extra $3 dollars a day, it dawned on me how applicable this scenario is to real estate investing. In fact, when I finally got to the counter to sign paperwork and get the keys, I asked the attendant why they were so busy. He fittingly answered, “Aw man, it’s because we have the best prices!” Indeed, they did have the best prices, but I found myself wishing I had paid just a little more money for a better experience.

The same goes for investing. I’ve talked to a number of investors over the last few years who called my company specifically looking for the lowest priced property possible. They had heard that you could buy properties in Atlanta for $30,000 and wanted to know how they could get one.  While it is true that there are distressed properties in certain parts of Atlanta at this price point, the better question ought to be where  can I find the most profitable properties with a solid and consistent ROI?

The problem I’ve found with buying solely for the lower price point is there are too many negative characteristics to the investment that don’t initially pencil out on paper. Similar to my experience with the rental car, many of these nuances don’t show up until after a property is purchased.

Here are just a few of the concerns I personally have with buying at the lowest price points:

  • Super cheap properties often equal older housing stock. Old properties typically require more ongoing maintenance that can kill future cash flow.
  • Low end properties are typically harder  to lease.
  • Unfortunately, there is simply a difference in the caliber of tenants that rent in the lower rental amounts as compared to those that rent in the average and higher rent range. This typically means a higher rate of eviction and turnover.
  • Another highly correlated factor with lower priced properties is crime. Intuitively, the cheaper the properties, the worse the neighborhood and higher the crime rate. Most investors don’t factor cleaning graffiti off of their rental properties or replacing stolen A/C units when developing a pro-forma.
  • Another less tangible factor in lower end homes is the future resale of the property. Many of the lower priced properties today are located in neighborhoods that are mostly rentals and as such, may be difficult to sell at some point in the future …. At least not to a retail buyer and probably not in line with the appreciation rate in the market.

I realize I will probably get a lot of comments on this blog from investors who bought a deeply discounted property and have had tremendous success and cash flow ever since. It’s not impossible to have success with cheap properties. However, on the whole, investors have the opportunity to make just as good a return on a slightly higher priced property and avoid many of the pitfalls associated with low end properties.  In many cases, even just jumping from a neighborhood selling in the 60K range to a neighborhood selling in the 90K range can make a ton of difference on the overall experience.

The bottom line is that an investor who chooses to buy properties specifically for the rock bottom pricing will have a much better opportunity for success when going into the transaction with eyes wide open. If the initial pro-forma utilizes a very realistic and conservative approach (including additional costs and expenses associated with the factors I listed above), the possibility of being disappointed or overwhelmed by unexpected costs is reduced. Perhaps my experience with the rental car would not have been such an ordeal had I fully expected on spending an extra hour of my day in line in exchange for the discount I received.

Photo: Jeremy Burgin

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About Author

Ken Corsini G+ is the founder of Georgia Residential Partners, LLC - a real estate investing firm based in Atlanta, Ga focused on creating turn-key investments for investors all over the country. He's been investing in real estate since 2005 with hundreds of real estate transactions.

16 Comments

  1. I’ll hand it to my wife, a retired teacher, for this and many other firm principals in our SFR investing. The house must be in a top high school district, a 6 or better from Great Schools. Cheap houses in great school districts are bargans and we agree with you entirely re cheap houses in 3 or worse school districts!!! No one cares about the house, their kids and probably themselves in crappy neighborhoods with crappy schools…

    A comment re Atlanta, my home town and a place being invaded by Venture funds, with boat loads of cash. They are buying the cheapest houses, in the crummiest neighborhoods in the crummiest school districts all because some local management company’s spread sheet and it’s stated cap rate. I predict it will ALL BLOW UP. And I will laugh. Too bad though. Idiots will too much cash and no common sense are ruining it for the renters, the neighborhoods and yes those poor schools will hardly get any better,, you think?

    Nice article and sorry about your rental. Thanks for that reminder. I might have done that myself.

    curt

  2. Jeff Brown

    Stellar, as usual, Ken.

    I ask folks who scoff at my opinion (which is in full agreement with yours) of the super cheap real estate around the country’s various ‘hot’ markets. “Ever wonder WHY they’re so cheap? Cuz they’re unadulterated crap, that’s why. Short term, flipping, in ‘n out quickly, I certainly understand. But do you seriously think you’ll want that as your income source in retirement? Take a breath, laugh at yourself, and resume rational thought.” Works almost every time.

  3. Ken,

    Nice article.

    We have a lot of “cheap” properties here in Memphis and as you say you can make money with them. But I hope some of these buyers know what they are getting into. I like to think of it as the other form of “hard money.” They are cheap for a reason. Do your homework folks when looking at “cheap” properties.

    Kevin

  4. I just closed on a duplex that is top notch quality. I really like it. Good stuff, and I look forward to da’ cash flow.

    In contrast, there is this rental property near where I live that I happen to see everyday. There is a tacky “FOR RENT” sign in it’s front yard. The place looks like where Uncle Jed lived before he moved to Californy, and I wonder, “who would want to rent that?”

    The difference is huge, and I’m glad I bought quality not uber discount.

  5. Personally, I look for super cheap properties in decent areas. The area may be lower income but far from slum. You can avoid many of the pitfalls by conducting Due Diligence. Make sure the house is structurally sound. Renovate all major parts before renting so no worry there. Choose quality tenants. Property may be cheap because it needs some work, good for me and you. Value will increase over the years given current lows. Give to property manager if you can’t handle during retirement. Cheers.

  6. For a creative investor, deals are everywhere, even in the hottest markets, because we don’t just look at a bunch of MLS REOs and try to find deals. And please don’t diss all cheap properties, but realize that the more time you put into this business–assuming your time is productive, not just busy–the better deals you can find. Though I’d only driven by it (and noted it was occupied) I bought a small 3 BR house in a nice part of a small rural farm town for $175 at a tax sale a few years ago, rented it to the current occupant for $200/mo on my way out of town, and left $25 richer than I’d arrived that morning. Sold it on terms for $20,000 a couple years later, and now enjoy a $290 check every month for my time. It was a small deal, but a fun and instructive one to talk about. And no, I didn’t learn that from John Beck, tax sales are mostly just about showing up, and seeing what you’re planning to bid on.

    I’ve bid and bought using pretty much every REI technique over the years, and found many good deals, including some for zero $ down, just did one last week. The more tools you have, the more you’re able to find a deal where others can’t.

    My point, and I’m far from the first to say it, is that “you cannot win if you do not play” (from an old Steve Forbert song). If you don’t show up, you’ll never know what you missed.

  7. Hi Ken,

    Great article…………. : ) I am a principal commercial broker in Georgia.I focus on the commercial side.I represent many clients who initially are looking for yield only.These are usually very busy professionals with liquid cash.

    Once I explain as you did how the yield in the long run isn’t there with low quality assets in bad areas they say they don’t want it. I usually help them with a better quality apartment building or a triple net property. They get a 7 to 10% yield without the headache detracting from making the money with their chosen profession.

    I can tell you that I hear maybe one success story in low income properties bought cheap for every 15 nightmares and the comment they will never do it again.At first some will comment that it is not that bad but then ask them again 6,12,18 months down the road and they are singing a much worse tune.

    I looked in the city of Atlanta for myself years ago and didn’t like what I saw at all.Even with me being a broker and getting it ultra cheap it didn’t make sense.The property taxes are very high in the city of Atlanta and over valued.Many of these foreclosed properties were fraud from a previous flipper during the boom.Someone put lipstick on it and then it appraised out really high.The new owners after a hot market refied out and spent the cash.

    The property foreclosed and now in addition to renting out for say 500 when the yearly taxes are 2,000 or more the property needs real work in plumbing,foundation,etc.

    In the years to come even if you had a renter that paid on time with no issues (rarely happens) the future repairs will destroy returns along with little to any appreciation.

    Most investors I know that buy houses in Atlanta buy outside the city in neighboring counties.Better areas,better rents to sales price,lower property taxes etc.

    In the long run those types of properties have a mix of appreciation and rents and better quality of tenant .

  8. I think it all comes down to the needs of the investor or my clients.

    If someone wants to quit their job and they need to jump off of 30,000 they have in cash then chasing yield,dealing with headaches for years until you can support yourself and leverage up into better properties makes sense.

    If you are a busy professional pulling down hundreds of thousands of dollars a year,running multiple businesses,or looking for quality long term assets to hold for retirement you value time and security over extra yield.

    My clients already have high net worth so they do not want problem properties in bad areas.

  9. Again, quality houses with quality tenants in lower income areas are fine. We don’t want complete slums however. The property is only a problem if the landlord does not have experience. Landlord must maintain property and screen tenants. Same goes with mansions. Period.

  10. Nicely said, Ken. This week an agent in our brokerage closed on an $1800.00 SFR. No, there are no zeros missing on that price. I’m sure there is a reason this home didn’t sell at it’s original price of $3,000. That being said, I hope the buyer does great things with this property. I hope he got a steal and can flip it or rent it, but when I get calls- from Californians mostly- who are hellbent on buying a property like this, I pass them along to another agent. I just don’t want a phone call 1 year later begging me to help them sell their home because they can’t rent it or it’s way more work than it’s worth.

  11. I bought my rental cheap, but it was a matter of the budget I had, and the construction skills I have which allowed me to purchase a very large (but distressed) manufactured home. I’m not a “professional” investor — I have one rental, managed by my parents who have 4 small rentals in the same small rural northern CA town, but so far so good. I have definately made mistakes ( I “invited” my first renters to leave…). I was fortunate in that my timing was excellent (Aug 2010), and some of the “scary” (mold) was a result of one-time events (a pipe burst) and the “ick” was fixable (3 years worth of hound dog pee were wiped out by carpet removal and 2 coats of kills within 12 hrs of the close of escrow — amazing improvement for under $100!). The other problems (moldy drywall and squishy subfloors) were quite a bit more time/money, but I hadthe major items repaired within budget and rented out in 6 weeks. Even with some mistakes (not doing a thorough enough background check on my first renters) I’ve been able to better-than-break-even, so the first two years profits have been put back into improvements/upgrades to make it a “very desirable” rental vs. an “adequate” rental. So far so good with “cheap”, but it’s a “buy & hold”, not a “flip”.

  12. I agree that the over all profitability is what should determine the validity of the investment. As long as the property meets all the criteria to justify the potential profits. There are a variety of reasons that a property can be listed for a really low price in a very desirable area. We are putting together the numbers for one that the SFR was into a reverse mortgage. Apparently the home owner had lived there for many years before their death and the balance for the mortgage is under 25,000. It is surrounded by what is our middle class at 130,000 to 150,000. It does need a lot of work, but still appears to be a no brainer.

  13. I also purchased a property in India at a very cheapest price In Skye Luxuria, at present they are a new township launched and are selling out the properties at a very cheapest rate and the location around is too superb and good. It’s a open opportunity for all evenly the Foreign Investors to come and make purchase of property at Skye Luxuria here as they are selling out at a very cheapest rates. Good place around at very cheapest rates and nice Township to invest your money and in budget.

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