Is there Such Thing as Buying Too Nice of a Rental Property? (Hint: The Answer is Yes.)
I actually wish I wasn’t telling you there is such thing as too nice of a rental property because it might mean that I’m not experiencing this first-hand as we speak but, unfortunately, I know for certain that it is possible to have too nice of a rental property! I have one now and it’s not looking pretty. Not the house, it’s actually too pretty, but the situation.
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I can’t find renters!
Would you believe it? At first I wanted to second-guess my property manager but I’ve been working with him forever and I know he’s not the problem. The problem is: the house is too nice. It’s newer (2007), big size as far as how rentals usually go (2100 ft2), 4 bedrooms/3 bathrooms, and it is in an amazing location south of Atlanta. The location is great because it’s only a mile off the main freeway and half a mile from a lot of major commercial shops and restaurants, but you’d never know any of that stuff was there if you were standing outside the front door. It’s a very quiet, wooded, cute little neighborhood, and I’d say it qualifies as primarily upper middle-class. It’s not quite to the full designation of upper middle-class in my opinion, but it’s not far from it. All of this about the location was a lot of what had me filled with excitement when I was looking at it. Atlanta was starting to appreciate at the time, I knew there was a lot of appreciation to be had in the market itself, and if any property in particular had a lot of room to build equity, it was this one. On top of that, the monthly cash flow was scheduled to be amazing. I bought the house for $94,500 and it was rented out at $1300/month with low taxes and insurance, plus it was fully rehabbed and in amazing condition so it was doubtful there’d be any major repair expenses anytime soon. So the cash flow was great, the property had so much appreciation potential, and it was just a stinkin’ cute house.
At first when the tenants who were living there when I bought the house stopped paying and were eventually evicted, I thought it was a fluke. Then the property manager (who was a different manager than who has the house now) put in a second set of tenants (like 4-5 months later, which was already causing me stress in itself), I was super excited because they even paid an extra month’s rent upfront and everything seemed to be great. Sure enough though, they stopped paying too. It was a repeat all over again of the first set of tenants. Because this was a property manager I hadn’t used before, I had every bit of faith in the fact that obviously this manager was horrible. He clearly couldn’t screen tenants and I know for sure he was giving them too much leeway to be able to pay late and try to make up missed payments. That part I should have nipped in the bud immediately, but in general I just knew it had to be this guy. So, before the second set of tenants were even out of the house, I fired that property manager and reassigned the property to my usual PM. I knew he could fix the situation as he had always been amazing in the past and was doing a great job with my other properties. I was so excited to have him take over the property so now it could reach its full investment potential.
That was last September. It is now April (and this is no April fool’s joke) and there are still no tenants in the house.
At first I understood there is always a little lag time, it seems like, once a property is marketed to really get traction of people looking at it and from those people, sorting out the good ones. So there was some lag time. Well that lag time put us into the beginning of the holiday season, and if you have ever owned a rental property, you know holiday season is a horrible time to find tenants. I mean, who looks for new places to live at Christmas? Not many people. So there was the holiday time. As we started coming out of the holidays, I got excited thinking it was time for a tenant. I wasn’t hearing anything, so I asked. There had been a few calls, but that was it. I was confused as to why this would be the case. Other than the house I used to live in that I now rent out, this house is the nicest rental property I own! What in the world? I gave it another week or two and asked again. They had gotten two applications. One woman seemed good but when the PM started requesting documents to move forward, she wouldn’t answer the phone. I’m always of the mindset that how things end are the same way they begin, so I was totally against this woman moving in even if she did suddenly pick up the phone a week later. No idea what ever happened to her. The other application was for a section 8 tenant, which normally I’d be fine with, but apparently this one had six children under the age of, something young, and didn’t have a fantastic background. Nix. That was the end of the application traffic. Now it was March. I had talked to my PM on and off during all this, but at this point we finally had to really sit down at length and figure this one out. Just to be clear, the PM is great. I’ve never thought twice that he wasn’t looking for tenants in the right places, advertising, or anything like that. He’s done amazing with my other properties so I had no doubt something different was going on with this one.
My PM told me specifically, “one problem is everyone who lives in this area and the closest neighborhoods nearby are home owners, not renters.” As much as I always encourage people to buy rentals in neighborhoods that do have owner occupants (helps with tenant quality, appreciation potential, and general enjoyment), I had picked a property that went too far to that end of the spectrum. Fantastic. But seriously, no interest? So we talked about getting more diligent about advertising it on rent-to-own websites and putting tenants under a lease option to buy if that would help drift more towards the owner occupant-desiring crowd. At this point I even had my PM run some comps and decide what he thought the property could go for, considering the 20%+ appreciation in Atlanta over the last few years, I figured it would have to sell for something decent. The comps didn’t seem to support it (have I ever mentioned shooting for appreciation is like looking in a crystal ball?). Great! I was at a loss.
Ironically enough, a couple weeks after my PM listed the property for sale just to see what happened, he received a cash offer to buy the property for $130,000. This amount was what I had initially set as my minimum price I’d be willing to sell it for, since I had bought it for $94,500 and needed to profit after all financing costs, interest, and hello mega vacancies. I agreed to the offer, signed it, and the property is in escrow now as we speak. I have my hesitations as to whether the property will make it to close or not because of the unsupportive comps, but who am I to criticize a cash offer. The property is still listed on rental sites as well to see what happens on that front, if anything. So far, still nothing.
I am the biggest supporter of buying higher-quality properties and while I’ve always known it didn’t make sense to buy the really fancy stuff, because the cost of them surpasses the income you can collect, I didn’t realize where the line really was as far as a property being ‘too nice’ to be a good rental.
Some parting thoughts I’ll leave you with based on this experience:
- I talk to a lot of people who can’t understand why they wouldn’t want to buy a property in the A-grade neighborhoods of any particular market. There are some A-grade neighborhoods that could work, but more often those areas are the significantly more expensive areas, best school districts, and upper middle class if not higher… meaning, most everyone is more likely to be a homeowner. At least in the markets with investor-friendly price-to-rent ratios they are likely to be homeowners. If there are more renters in the nice areas, it’s a likely indication that the price-to-rent ratios are not advantageous to investors for rental properties there anyway. This is exactly why B-grade neighborhoods and areas can be much more profitable than the really good stuff in terms of cash flow. If you just want an A-property due to looks, bragging rights, and appreciation potential, fine, but at least admit that’s what you’re out for rather than a cash-flowing investment.
- As part of your due diligence in selecting a rental property to buy, call at least a couple local PMs and ask their opinions on that neighborhood specifically for rentals. Ask them about the ease of renting there and the typical quality of the tenants. For example, if someone was looking to buy a rental property in the same neighborhood as mine and they called my PM, my PM would easily tell them he’s had a horrible time renting it out and that should be discouraging to a potential investor. Turns out, had I talked to him before I bought this property he says he would have cautioned me about that area because of how hard it is to find renters.
- Never buy just for appreciation potential. I didn’t buy this one under that thought as the cash flow was scheduled to be amazing, but I had high hopes for appreciation because of how fast Atlanta housing prices were climbing and predictions for the market. Atlanta’s prices did in fact rise, but for whatever reason the comps around this house only tacked on about $6,000 to what I originally paid for it.
- Just because numbers are written out and look fancy on paper doesn’t mean they will pan out. The 10% cap rate and 20% cash-on-cash return that was supposed to happen certainly didn’t. I have lost money on this house, no question.
- Even when you do extreme amounts of due diligence, you can never account for every potential issue you might hit with an investment property. Because of this, I encourage you to always keep good margins when estimating returns on a property. Be conservative with your numbers, leave some room for error, and don’t buy a property that can’t provide those margins. On the other end of the stick, because you can’t account for every issue no matter how diligent you are, don’t try to be a perfectionist. No matter how thorough you are and no matter how much research you do, you can never predict 100% what will happen. Heavy duty stress will just wear you out and not make your buying decisions any better. So find that fine line between doing thorough, accurate due diligence and becoming a perfectionist. Somewhere in the middle of those two is the best place to be.
Any experienced investors out there that have had any freak accidents with properties that they never expected to happen?
Photo Credit: Steven Martin