Real Estate Deal Analysis & Advice

Should I Buy Several Cheap or a Few Pricier Houses? An Investor’s Analysis

Expertise: Personal Development, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management
42 Articles Written
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I get this question all the time: “Should I buy cheap property somewhere else with higher cap rates or more expensive property where I live?”

I wanted to buy cheap property once. It’s very tempting. So is it a good idea? Let’s run some numbers and find out.

Most investors turn to cap rates to decide which property to buy, almost like a magic wand. But cap rates can be deceiving and should be used with caution because there is a lot they don’t take into account.

What is a cap rate exactly?

Cap Rate = Net Operating Income/Sales Price

  • Net operating income is simply the yearly gross income minus operating expenses (i.e. property manager, yard maintenance, vacancies, repairs).
  • Sales price is what you will pay for the property.

Related: The $30k Rental Property: How to Finance & Profit From Cheap Real Estate

Real World Example

We’ll use two very different different homes for this example.

Expensive Property

  • You make $29,000 a year in rental income
  • Property costs you $270,000
  • Manage property yourself
  • Yard maintenance is $1,200 a year
  • Vacancy loss is about $200 a year
  • A typical year in repairs costs you $1,000 (not replacing major components)
  • NOI: ($29,000 – $1,200 – $200 – $1,000)/$270,000 = 0.099 or 9.9% cap rate (very good for a single family home)

Dirt Cheap Property

  • You make $6,000 a year in rental income
  • Property costs you $30,000
  • Manage property yourself
  • Yard maintenance is $1,200 a year
  • Vacancy loss is about $100 a year
  • A typical year in repairs costs you $600 (not replacing major components)
  • NOI: ($6,000 – $600 – $100 – $1200)/$30,000=0.14 or 14% cap rate (unrealistically excellent cap rate to prove a point)

Based on the analysis, the cheaper property has a lot better return on the income invested. What most people don’t put into cap rates is the cost of major repairs which tend to be similar between really cheap and more expensive houses. Let’s see how that changes things.

BRRRR-strategy-deal

 

Here is an example of prices for different components of a house and how fast they wear out.

Lifespan Cost Cost Per Month
Paint

8

$2000

$21

Roofing

20

$4000

$17

Oven

15

$700

$4

Washing Machine

10

$500

$4

Dryer

10

$500

$4

Interior Paint

15

$1500

$8

Carpet

10

$3000

$25

Bathroom and Kitchen Linoleum

15

$700

$4

Furnace

20

$3500

$15

Kitchen Remodel

30

$15000

$42

Bathroom Remodel

30

$5000

$14

Total Monthly Cost

$157

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More expensive property:

  • Monthly income = $2,400 – mortgage ($1,600) = $800 a month left over
  • Average operating expenses are $200 a month
  • Average costs to repair major systems in the house over time are $157 a month
  • Monthly profit $800 – $200 – $157 = $443

Less expensive property:

  • Monthly income = $600 – mortgage ($142) = $458 a month left over
  • Average operating expenses are $158 a month
  • Average monthly costs for major systems in the house $157 a month
  • Monthly profit $458 – $158 – $157 = $143

So, to make the same monthly profit while paying off the loan as a $270,000 house, you will need three $30,000 homes. That might not be bad. Considering that you are putting 20% down on each investment, you will make more monthly profit per dollar invested when buying the cheaper homes. It doesn’t end here. There is so much more to consider.

Appreciation

What about appreciation (increase in home value over time) if you want to sell one day? Let’s say appreciation is 5% for the more expensive home (that’s why homes are more expensive in those areas) and 3% for the cheaper home (that’s why prices are cheaper in those areas).

If you wanted to sell in 20 years, the cheaper home would be worth about $54,000 and the more expensive home about $720,000. A little after year three, you will have made more in just appreciation (not including profit or pay down) on the more expensive house than the cost, appreciation and profit of the cheaper house. By year 18 you will make more in appreciation every year than the cheaper house costs. To get the same appreciation return using cheaper homes, you will need to buy and manage 13 ($390,000 in cheaper homes) of them.

Let’s look at how much your time spent managing was worth in just appreciation assuming three hours a month per house over 20 years. The cheaper house will be worth $75/hour and the more expensive home $995/hour. 

Management Time

Let’s say you pay the houses off and want to retire on that income. If you manage the more expensive property, you will make $2,400 a month (assuming the value of money never changes over time). You will need 5 cheaper properties to get the same amount of cash flow. In other words, you make 5 times more per hour of work with the more expensive house.

Going the more expensive route gives you a lot more time to do things that truly make you happy. That’s why we invest in the first place, right?

Related: Why Buying Cheaper May Come with a Hidden Price Tag

Economy of Scale

At the front end, cheaper properties are very tempting because they can bring in more money per dollar. At the back end, the more expensive properties bring in a lot more per amount of work and per year from appreciation. Whichever you choose is up to you.

I’m sure some of you are thinking, “Well, I can’t afford an expensive property.” My advice to you is to buy what you can afford as long as there is cash flow. Over time you will be able to gain equity and save up money so you can buy something that will increases your income per hour.

Things to keep in mind:

  • Costs for long term and short term repairs are similar between cheap and more expensive properties because of the cost of materials and labor. This usually isn’t taken into account when using cap rates.
  • High end homes will tend to have much lower cap rates, but the income per effort will be much higher.
  • Low end homes cash flow better, but you are more likely you will end up with tenants who don’t take care of your property and end up costing you more in repairs. The time you spend finding tenants and dealing with problems goes way up. They won’t be the same between cheap and expensive properties.
  • Don’t go too high end. It’s easier to find tenants and keep vacancies low if you buy properties in the price range most people in your area can afford. Higher demand properties are going to be easier than higher end properties.

“Happiness is not something ready-made. It comes from your own actions.” —Dalai Lama

We are republishing this article to help out our newer readers.

So, what do you think, investors? Have you opted for cheap homes or have you gone the pricier route?

Leave a comment, and let’s talk!

Brett Lee is a licensed Real Estate Broker in Portland Oregon where he helps people achieve a better future so they can do the things that truly make them happy. Brett is also a buy-and-hold invest...
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    John Murray from Portland, Oregon
    Replied over 2 years ago
    The concept of buy low and sell high as well as minimize time and money spent is the key to the overall goal of any investment. Like the author I live and invest in Portland Oregon. My area of expertise is not only cash flow but the overall goal is maximize depreciation, pass through passive loss, maximize capital gains while minimizing tax burden. One could debate the purchase price of an investment but if the investor uses the goals mentioned, that investor will be successful in reaching the larger picture of wealth building.
    Nathan G. Real Estate Broker from Cody, WY
    Replied over 2 years ago
    I like this form of comparison analysis but we have to be fair with realistic numbers and include everything. Buying three cheap homes is easier than saving funds for one expensive home. Cheap homes have higher vacancy rates and more problem tenants, but you get the benefit of three properties instead of one. I view the cheap home like apartments; more doors at a reduced price comes with additional risks but it produces a greater return for the savvy investors seeking to maximize cash flow.
    Corey Adams Investor from Joplin, MO
    Replied over 2 years ago
    In my market something I’ve noticed about the expensive homes that would cost 270k and rent for 2400 typically take months to rent out. That what I’ve seen on the MLS at least. But I can rent out a $600 2 bedroom in less than a week. I live in a pretty blue collar town in Missouri though so that’s where most of the demand is at. I think there is always a sweet spot in every area between high end and low end. I just really can’t get behind any house that rents for less than 1% of the purchase price. Numbers just don’t add up for me.
    Charles Oglesby from Orange County, California
    Replied over 2 years ago
    Different strokes for different folks. Poor comparison here though. The fundamental flaw of comparing a 30k home to a 300k home instead of TEN 30k homes makes this article unreliable. What was 6k in annual cash flow should be 60k, compared to the measly 27k from that 300k duplex if we are talking California values. At this point nobody can convince me to take on debt to purchase over priced multi family. The only opporutnity is in the depressed markets not the over inflated ones that are bound for a correction, a correction that will occur as more and more people flee those areas into our hands.
    Justin Bermudez from Montezuma, Colorado
    Replied over 2 years ago
    If you came in with different numbers than I think a lot more people might agree with you.
    Rob Cook Real Estate Entrepreneur & Coach from Powell, Wyoming
    Replied over 2 years ago
    Brett, you obviously gave all of us a lot to think about! And that is the highest value of blog posts and forums! So good job! One over-riding principle and take away from this all is one-size-does-not-fit-all. Whether regarding price ranges, affordability for individual investors, assumptions on expenses, whether to consider appreciation or ignore it, market differences across the country and even competition of owner-occupant purchasers. There are pros and cons of either price range discussed. Many actually. I have experience in both ends of the spectrum, with a number of single-family rentals priced between $800K and $950K. (Only one was bought as an investment property, and I paid $167K for it). Inflation can be your friend! Even on low priced properties. But counting on appreciation is usually gambling. I consider it a bonus if and when it occurs, and it has fueled my real estate investment business for sure, so hate to disregard it. BUT I never include appreciation in my purchase analysis for a potential rental income property. Here is an actual deal I had to illustrate how it CAN all work out amazingly. Even without the crazy, lucky appreciation, it was an awesome investment as a rental. A single tenant, no vacancy, no fixup cost to sell it, and no sales costs or time on the market. A True Example of one of my $30K-$40K deals $1,200 s-8 rent per month 79 months rented Mar 1999 to September 2004 $94,800 gross rent collected $40,600 Purchase price $15,000 Fixup costs $55,600 Total fixed up cost $320,000 Actual Sales price – closed in 2 days after vacancy – NO cleanup at all $264,400 Net equity gain realized $359,200 Total cash benefit of owning for 6.8 years – Gross rent plus Equity gained
    Luke Ski from Columbia, Maryland
    Replied over 2 years ago
    Well, my cheap properties have one or two small baths that are very cheap to rehab, and just 2 bedrooms which are also cheap to paint and fix up.Kitchens are also smaller and very simple. Cheap properties are usually smaller , with small AC units, smaller roofs, smaller yards (if any), less windows , less floors that need to be carpeted or tiled. My large property has 4 bathrooms , 4 bedrooms , big roof, large AC unit , twice as many sq ft for flooring. Larger kitchen that must have more expensive appliances , nice countertops.Your math is way OFF and inaccurate. Cheap properties are cheaper to fix and maintain , expensive and usually larger properties are more than twice more expensive to rehab, or maintain. Most investors can afford 30K property or a few of them, but only a few can afford even one for $270K.
    Max Miller Investor from Ypsilanti, Michigan
    Replied almost 2 years ago
    I agree that less properties equals less problems. So much in fact that I like to own my properties free and clear. That allows me to cash flow around $14k/yr per property. I also keep my expenses low and could live off just one. More properties sounds great but the reality is that it is just more to deal with.