Why Buying Cheaper May Come with a Hidden Price Tag
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.
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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