Don’t Buy That Cheap Property! (UNLESS…)

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It’s a fact, Josh Dorkin hates Detroit (and Rochester, Buffalo, Columbus, etc). 

Anyone who has listened to the BiggerPockets Podcast each week is just waiting for Josh to take any random topic and turn it into a way to bash Detroit. 

In this week’s podcast Josh decided that he was no longer going to talk about Detroit.  Instead he was going to tell everyone why “Podunk” Washington (aka. Aberdeen aka. Brandon’s investing area) is the new Detroit.  But Montesano is just the latest in a list of cities that Josh has rattled off that people (especially new investors) should not invest in, even though they have cheap properties.

So the question comes up… why does Josh hate cheap properties?  Is he destined to spend too much money on investments because he hates these cheap properties?  If you’ve listen to past podcasts, you will know that Josh, in fact, does not hate cheap properties [EDITOR’S NOTE: Josh doesn’t, in fact, hate any of these or other cities either], he hates cheap properties that are not good deals.  

And you should should too.

I’m Looking For a $30k-$40k Property

In the forums this week, a discussion started around this very topic.  A new investor in my area (Rochester, NY – another area that Josh has added to his list of areas to avoid) was asking about getting started and said “I’m looking for a 30k-40k property”.  Knowing how much you want to spend is important, but it is not the main criteria that you should be focused on when evaluating investments.  Instead you should be looking at things like:

  • What are your investment goals?
  • How much cashflow (profit left after all expenses paid) does an investment yield?
  • How much cash on cash return (cashflow compared to your investment) does the property yield?
  • How much of a headache factor will the property be?

Saying you want to spend $30k – $40k when you want yo purchase a car is fine, but it is not the most important criteria to focus on for an investment.

But Tom, Your First Investment was Only $26,000

If you’ve read any of my previous posts or listened to my podcast, you probably know that my first investment was a duplex that we purchased it for $26,000.  This may make me seem like a hypocrite because this is a cheap property, but that is not the reason that I purchased it.  I purchased it because the numbers worked and it made sense for me, which makes it a good deal.

  • Investment Goals: To get started in buy and hold real estate.  The duplex was in my target area and was an easy way to get started in real estate and learn the ropes.  It also seemed less risky because their would be 2 rents and vacancies would not be as painful.
  • Cashflow: Monthly rents are $1,225 for this property.  Assuming the 50% rule, NOI comes out to $612 with ~$325 in monthly cashflow after  a $288 mortgage payment.  This is above our target of $100 per unit.
  • Cash on Cash Return: Annual cashflow is $3,900 and we invested $8,000 for down payment and closing costs, so our cash on cash return is ~48%.
  • Headache Factor: This was our first property, so we were not really sure.  Since it was in our target rural area and the rest of the criteria matched, we took a chance.

So for us, this was cheap and a great deal, so we purchased it.  We have skipped over other properties that were around the same price or cheaper, because when we ran the numbers or looked at the other criteria that was important to us, it just would not be a good deal for us.

So Josh In Fact Doesn’t Hate Cheap Properties

Going back to the investor and the forum post, another investor from Rochester (Steve Santacroce) chimed in and provided the following advice:

“You don’t want to start investing in Rochester on 30-40k houses. You need to find yourself a VERY good property management company that has experience dealing with the headaches and issues that come with houses in those kinds of neighborhoods. If you want a fairly turnkey property, expect to pay at least 90k for a nice duplex that could give you a reasonable amount of cash flow.”

And this is why Josh and many other seasoned investors really try to drive home that cheap property does not make it a good deal.  It is important for people to realize that price is not everything and it is important to look at the entire picture when evaluating a potential deal.  Does the area support the type of investing that you want to do?  Do the numbers look good on paper?  Will you be able to achieve the numbers on paper in real life?  These are all very important questions to ask.

What is your view on cheap properties?

Photo Credit: Un-Alien-able

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About Author

Tom is a serial entrepreneur and real estate investor from Rochester, NY. His real estate investments primarily target multi-unit properties. Along with his wife Ariana, they run a blog called Entreprenewlyweds, which helps couples understand how to manage being real estate investors/entrepreneurs while also maintaining a great relationship and family life.

23 Comments

  1. Another great article Tom! Knowing what your investment goals are and the numbers are the keys to successful investing.
    Bash away Josh, Rochester rocks for investors!

  2. Joshua Dorkin

    I hope you had fun with that one, Tom.

    Of course, you know that I don’t have anything against ANY of the cities that you rattled off. Instead, as you mentioned, I do think it is extremely important to reiterate the point about cheap properties vs. good deals. In all these markets, we can find inexpensive properties, but I press upon new investors to be cautious.

    So — I will continue my schtick until I no longer hear stories from new investors who get caught up in the hype of “cheap” properties.

    SIDE NOTE: There are GREAT deals in all the markets that I “hate” — but it takes local knowledge and experience to succeed, I believe.

    • Josh, I think you nailed it there. There’s a lot of due diligence that goes into analyzing cheap properties, and local knowledge is a big factor. One cheap property here can become a cash-flowing dream, while what on the surface is a similar cheap property is a nightmare that will suck your wallet into it.

      • Ben – Exactly. We’ve passed over properties in our area that were much cheaper than the deal I mentioned. One example is a property that was $10,000. We live in NY, but somehow this property has no heat source (ex. furnace). I have no idea how this was possible, but we should have had to add a furnace and install all of the venting throughout the house. Then it did not have a driveway, and because cars can’t park on the street overnight in the winter, our tenants would not have had a place to park their cars. And finally the ceiling of the kitchen in the 1st level unit was 6′ fall. Either we would be renting to very short people, or we would have to spend a ton of money to fix it.

        But on the flip side, we did purchase another property for $10,000. A guy bought it from a tax auction, but realized that it was too much work after he saw it. After 3 dumpsters, we basically had a house with good structure that just needed to all the guts upgraded. That one, even though it looked a lot worse, was actually a much better deal.

  3. Cheap properties don’t all have to be in bad neighborhoods either. I have some cheap properties in the suburbs of St. Louis. Decent schools, low crime good population trends etc etc.
    Your point holds true, evaluate the deal to make sure it makes sense from multiple angles. A 200k property can be a homerun and a 10k property could be a nightmare. It all depends on everything else involved.
    Good post to see the forest through the trees.

    Jason

    • Great point about the neighborhood. Part of the reason we chose our investment area (rural) was because these small towns had cheaper properties with great cashflow, but very low crime and good schools.

  4. One issue with cheap properties, which I think you even had a problem with in your first deal if I remember your podcast correctly, is finding a mortgage, if you need one. At those low price points, finding a lender is tough.

    Your message is very true. I think Josh’s message is also making sure people really understand the market they are investing in too. There might be some markets you can find a good/cheap deal in, but the outlook is trending down or has a long way to go to recovery, which means you could suffer vacancies or find yourself in a neighborhood transitioning the wrong way. Having a cheap property isn’t worth much if you can’t find tenants.

    So do your research and make sure you understand WHY the market is cheap. Nice article, Tom!

    • Sharon – You are spot on and thanks for bringing it up. We did have problems finding a lender for our first deal, although we were persistent and eventually did.

      On most of our cheap deals today, we often buy then for cash, renovate them, then re-finance them with the bank. This avoids that issue.

      “So do your research and make sure you understand WHY the market is cheap.” – This is sound advice for anything, not just real estate. Many people have said it, is it bad because it was mismanaged and you can improve it because you can improve the management and create value, or it is bad for another reason for which you can’t create a deal out of it. It’s very important to know the difference.

      • Since you mentioned refinancing…..has it been difficult to re-finance and reclaim your initial capital on any of these inexpensive properties? I’m also thinking of the Rochester area since I’m in Brooklyn and the prices to play in RE here in NYC are rather prohibitive.

  5. Tom – you are so right, a house is a house but the numbers tell the real story.

    Also, finding cheap deals is not so much the condition of the house but the condition of the owner. Distressed properties are named as such because the owner is distressed. They may be facing a looming foreclosure, have bad tenants or a myriad of other problems. The house may even be in great condition, but the final sale price is cheap because of intense motivation to sell. As long as the property makes sound investment sense, these are the diamonds we should be mining for.

    • Martin – Exactly! My favorite cheap deals are when the issue is with the owner, not the house. Unfortunately not everyone is cut out for investing in real estate, which leads to mismanagement or a variety of others problems. Finding a house that is in good condition but the owner doesn’t understand how to run a business can also create a great deal.

  6. Lol, this article made me laugh. Im all for a more nuanced approach. I think we’ve gotten a little comfortable in mainstream discussion by broadly saying their all headaches, when I eyes, ears, and analysis can show us otherwise. I can buy a 40k house in my parent’s neighborhood, but rents are $300 a month, and that’s not good enough for me. I can also find a 40k house that brings in $900/mo consistently within an hour’s from me, and now you’re talking my language. Real estate is local, nuance is everything. I hope more caveats are brought up more, so opportunities are missed with broad generalizations. Thanks for the article!

    • Lisa – I was hoping you would chime in as I know this is part of your niche. Those of us that can look beyond the basic information and can truly analyze a property are the ones that can identify opportunity and take advantage if it.

  7. Tom, areas that Brandon and other investors like us buy in: Aberdeen, Montesano and Elma, Montesano prices are a lot higher than the other two.

    Regardless of cost, if it doesn’t cash flow, you paid too much. Investing in good solid REOs is the “only” way to maximize your dollar and get the best returns.

    • “if it doesn’t cash flow, you paid too much”

      That is exactly it. When I run analysis on properties, I find the price that makes it cashflow for my target return and I offer that. If it is accepted, then we are all happy. If not, I move on to the next one. There is always another deal.

  8. I was in O’Hare Airport on Friday, where I found a newspaper advertising houses in a less then $200 section. How could one go wrong with a $200 house? Just ask for 3 months upfront, and abandon the place if they don’t make the next months rent. In my book that is a 100% return on my investment in less then 2 months. :)

  9. Sara Cunningham on

    Most of the property we own falls into this price bracket. However we probably looked at a potential 200 properties to find 10 that made sense. You need to spend the time and effort to sort the wheat from the chaff as they say. We always get inspections, including termite, look at potential rents, repairs etc before we purchase. It really does make sense to invest in areas you know really well to feel confident about moving forward though. I must admit I don’t know that I would feel so comfortable investing in a town where I didn’t know all the necessary information.

  10. Excellent points Sara. I’m a big proponent of investing in areas where you are knowledgeable. Just like you, we look at a lot of properties and only pick up a portion of them. Because of the local knowledge, we can separate the good deals from the losers.

  11. I fully agree with the point being made over and over again that you need to be able to distinguish between what is an inexpensive deal and what is just a piece of cheap garbage.

    I can find $500 houses to buy all day long, but they are just sitting there because they just don’t pencil out.

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