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How Does Location Quality Impact Flippers VS Long Term Investors?

by Jeff Brown on September 27, 2012 · 10 comments

  
bad location

Get some real estate investors in a room, provide some adult beverages and good eats, then ask ‘em about cash flow, price, and those factors’ relationship to location quality. Wait ’til they’re ready for the second round of beers, then ask ‘em whether or not their opinions might  change, depending upon whether or not the investment is short or long term. That’s a discussion that gets interesting quickly. The short term folks don’t really care all that much about location. They get in, get out, count their profits, rinse ‘n repeat. As long as nobody messes with ‘em in the process, what do they care about location quality? Frankly, with a few obvious exceptions I wouldn’t argue the point much.

Long term and Location

Then I ask the flipper if he’d care to own that ‘beautiful fixed up babe of a property’ for the next 5-10 years. Most of the time it gets quiet. They realize the reason they were able to buy so low was due to the quality — relatively speaking now — of the neighborhood. If it had been in high demand, the price woulda been higher, our first ‘duh’ moment today. ‘Course, my observation has been that most flippers simply don’t get into long term investing. If they’re one of the rare flippers who’ve figured out that side of the business, and it is rare, the money’s so good they simply keep the machine runnin’. But the ones who do see the benefits of having a long term column on their spreadsheets still can’t seem to resist the super low prices of less than blue ribbon neighborhoods.

That’s a huge mistake on several levels. Here’s just a few.

  1. Buying in neighborhoods in which you’d not put Mom or Grandma to live alone, means your tenants won’t be the quality for which you should strive.
  2. Whatever the operating expenses you’re expecting? They’ll be more. Your turnover rate will higher. Ditto on eviction rate. The same goes with maintenance and repair, as not so cool tenants tend to treat your property in not so cool ways. Who knew?
  3. If appreciation ever rears its gorgeous head again — and we should never impute that into any spreadsheet, ever — which neighborhood do ya think is gonna go up more and faster? Our second ‘duh’ moment.

    Flippers have such a potentially monster advantage over the typical long term real estate investor. They can use their after tax flipping profits, to the extent possible, to enhance and/or add velocity to the capital growth rate of their long term portfolio. In the long run just that one strategy alone can literally make the difference between retiring with a few rentals, or enough to generate a retirement income easily into five figures monthly.

    But to do that safely, the location quality should be stubbornly held to the highest bar possible. Put another way, ask yourself this question:

    If I had to retire tomorrow, and I could own a dozen rentals in the crummy to mediocre neighborhoods in which I’m flipping — OR — the same number in areas in which I’d gladly put Mom to live, which income source would I prefer? Which one would allow me to sleep better?

    See how your thinking changes when you put it that way? All of a sudden you begin to picture yourself in retirement, forced to rely on the flakes renting homes in the areas in which you flipped for all those years. Yeah, that’s the ticket — not.

    I realize I pound the location factor relentlessly. But my lifetime of experience has shown beyond rational debate that ignoring that foundational principle puts long term real estate investors on a one way street to disappointment, stress, and in too many cases, retirements that are more like serving out a sentence, than what was originally intended.

    Photo: Joseph Novak

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{ 10 comments… read them below or add one }

Sharon Vornholt September 27, 2012 at 9:03 am

Jeff-

Those are great points you make. I have found that most of my investor buyers have begun to run their businesses using pretty much the criteria you laid out. They want houses in nice areas even if those are bread and butter neighborhoods. I really don’t have a single person on my list that hasn’t upgraded their buying criteria.

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Dale Osborn September 27, 2012 at 9:12 am

Location – Location- Location – the mantra of realtors. Sometimes it does make a difference other times it does not really matter. Buying in a good neighborhood for long term buy & hold makes sense until the neighborhood starts to change for the worse. Then you need to dump that property and look for a better area. When we had apartments our goal was to someday own an “A” apartment in a nice neighborhood. Then, we observed there was better income in the lower income areas and decided the “C” market was our little niche. We lived on site at the last 3 properties we have owned so is no big deal. The main thing is treat all people with respect and you should not have any problems.

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Jim Pratt September 27, 2012 at 11:05 am

Hi Jeff, when I started buying rentals like most, I wanted the best deal possible. I could buy a $30,000 property easier than a $80,000 one, rehab and get positive monthly cash flow. Being sloooow, it took me a while to learn the better the neighborhood, the better the renters. Cheap properties will cost you time, money and profits not to mention headaches. I mainly buy “B+” class properties and doing OK now that I’m retired. In good areas, property apperciates a LOT FASTER as does the rents. If it wasn’t for the government and banks with property values so low, I would be buying all the “A” properties I could!

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Jeff Brown September 27, 2012 at 11:09 am

Hey Jim — I knew I’ve seen you at the sloooow meetings. :) I too learned this lesson the hard way. After a particularly bad experience brought on by my inexperienced location choice, he said, “Son, I love ya, and Lord knows you’re definitely smarter than the average bear, but sometimes? You are a seriously slooooow learner.”

He’s been gone now for a bit over four years, and I still think of that day several times every week.

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Jack Knochel September 27, 2012 at 9:20 pm

Great write Jeff. Was just talking about buy and holds this evening with a couple investors after our REIA meeting. We are on our 3rd rehab but need to start getting some buy and holds and plan to take the money from the flips and buy the buy and holds. We have one offer in for a buy and hold at this time and we’ll see if they accept it. Question for you: If you have $100k for buy and holds, do you try to pick up 5 homes with a $20k down payment or buy 1 or 2 with no or little payments and then wait for the next flip to get another? Hearing 2 different stratagies, one is leverage and have more props, the other being own and then go to the next or at least have a plan to pay off within a couple of years with flips. THANKS

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Jeff Brown September 27, 2012 at 9:26 pm

Hey Jack — Great question, and probably an answer worthy of a series of posts. I suggest you gimme a call when you can. Thinkin’ this is a pretty fun phone call.

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Jack Knochel September 27, 2012 at 9:46 pm

Hey Jeff,

Sent you a note, looking forward to chatting.

THANKS

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Ali October 5, 2012 at 1:51 pm

Hey Jack,

I’d love to give you my perspective on your question. My former life is all engineering, so I’m all for running numbers and figuring out how to get the best advantage out of my money, and I think I came up with a sound answer to your question. Would love to tell you about it. Email- [email protected]

Talk soon!
Ali

Ali October 5, 2012 at 1:54 pm

I think this article is spot-on. I’ve been doing a lot of investing in Atlanta in the last year, and I’ve bought the lower-priced properties with higher cap rates, as well as the more expensive properties with seemingly lower cap rates. As it turns out, exactly what the article mentions, vacancy, tenant quality, evictions, and repairs just go crazy on the lower-end properties. My lower-end one has gone through two evictions, stupid repairs, while my higher-end one has tenants on a 3-year lease with a lease option, so little to no vacancy, fewer repairs, better tenants in general. So worth the extra money upfront! Don’t be fooled by initial calculated cap rates. People are wanting the 15-20% rates you can find in Atlanta, but those properties aren’t in good areas, so watch out for the reality of those returns!

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Jeff Brown October 5, 2012 at 2:09 pm

Hey Ali — Nothing like experience as a teacher. You’ll probably never know how many financial headaches you saved others.

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