My Secret to Maximizing Cash Flow & Appreciation: Buying on the Fringe
There are tons of guides for out-of-state real estate investors on how to pick an appreciating market. Most of them cover the same principles: Invest in areas with increasing population, job growth, and salary.
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I’m not going to argue that those guides are wrong. Investing in rapidly-appreciating markets has made many investors wealthy.
However, many investors (like me) want to take a more active role in their local market.
My knowledge of the local market in St. Louis allows me to choose the right neighborhood. One that provides great cashflow with a high chance of appreciation—and with less downside risk than investing in a rapidly appreciating market out-of-state.
I would rather invest in a great neighborhood with potential in my hometown than in a hot market like Atlanta that's seeing a rush of competing investors. Atlanta might be growing fast and appreciating, but my local knowledge of St. Louis gives me the tools I need to make smart investments—investments that have allowed for instant equity on every purchase I've made so far.
The beauty of real estate is that it’s incredibly local. Market prices rise and fall on each block and neighborhood based on specific developments, regardless of the market performance as a whole
Every city is full of hundreds of unique neighborhoods. Noticing trends before other investors will allow you to build a cash flow-driven portfolio with the chance for rapid growth.
Buying on the Fringe
The strategy is simple: Invest on the fringe.
I buy in working-class neighborhoods close to areas that are known for being “up and coming.”
In almost every city, there is a street or neighborhood that used to be rough and is now known for being in the middle of a rapid revitalization. You will usually find investors pouring in to do high-end renovations and flips in that area. What you don’t see as much of are investors moving into the areas that are one or two neighborhoods away, but still close enough to be walkable.
These properties can still be purchased at workforce housing prices and offer incredible cash flow, with the potential of huge appreciation if the nearby neighborhood that’s rapidly improving spills over. If the neighborhood doesn’t end up appreciating, you’ve still built an incredible cash flowing portfolio in a stable neighborhood.
The hardest part of this strategy is identifying the right neighborhood and finding a deal that stands on its own merit as a great, cash flowing investment. Appreciation is only the icing on the cake, and while investing near high growth areas increases your odds of appreciation, it’s important to make sure you’re still happy with your investment, even if it never appreciates in value.
Related: When it Comes to Your Rental Portfolio, How Much Cash Flow is Enough?
Finding Your Fringe
If you’re thinking of investing on the fringe, you need to identify the right neighborhood to invest in.
The first thing I would do is look at all of the available multifamily or single family rental properties available for sale in your city and run a financial model on most of them. The BiggerPockets Rental Property Analyzer is a great tool to model potential deals.
After you’ve modeled most of the deals in your market, you should have a good idea of which parts of town work as investments for cash flow—and which ones you should avoid.
You should also have built up a decent eye to be able to see a building listed for sale, eyeball its rents and have a rough idea of whether it’s going to pencil out as a good investment.
Choosing a Winning Neighborhood
Now that you know where to zero in, it’s time to research and find your target neighborhoods. Investing in areas that other investors aren’t means that you should expect and look for areas with mixed opinions. If everyone told you that an area was great to invest in, it would be harder to find deals with great cash flow.
Here are several ways to research a neighborhood:
- Look at which areas are experiencing the highest year-over-year increases in permits being pulled. Permits = renovations and improvements.
- Google “[City] up and coming neighborhoods.”
- Google “[City] neighborhood development” and “[City] rehab areas.”
- Post on a local forum for your city (I use Reddit) and ask locals which areas are rough but improving, and then ask questions about the other areas nearby.
- See if any new and hip restaurants are moving into previously rough neighborhoods.
- Drive for dollars, looking for properties in need of renovation. Nothing beats an in-person experience. Start with a hot area, and expand your radius until you find a neighborhood with a good mix of property.
- Network with other investors who share your philosophy at local investor meet ups.
- Spend time exploring the neighborhood and hanging out in various restaurants, stores, and bars.
Testing Your Thesis
Once you’ve identified a neighborhood as a potential target for investment, it’s time to put that theory to the test.
When I first started investing in St. Louis City, I did this exact process for one of my favorite neighborhoods, Marine Villa.
I was first drawn to the neighborhood due to its proximity to Cherokee Street, one of St. Louis’s hottest areas that’s seeing a wave of revitalization.
A quick Google search of “Marine Villa St. Louis Revitalization” brings up several projects, the most popular an abandoned school being restored into apartments. I also found a blog post from 2012 about Marine Villa and how it had potential, but had a long way to go.
I then posted on a local St. Louis forum and received very mixed reviews, with some residents who lived there seeing huge potential and others afraid to invest or move into the neighborhood. I took this as a sign to do more diligence, as the locals were thrilled about their community, and most investors were still afraid to invest.
Related: How to Know if You’re Investing in the Wrong Real Estate Market
Researching new restaurants in Marine Villa led me to Sump Coffee, an interesting coffee shop that screamed potential.
Upon visiting, Sump Coffee is one of the most—if not the most—trendy coffee shops in all of St. Louis. It’s attracting an upscale crowd that doesn’t currently reside in the neighborhood. Across the street is another new restaurant coupled with homes currently undergoing high-end renovations.
While most investors haven't caught on yet, we weren't alone in our hypothesis that Marine Villa is ripe for improvement. There is a core group of investors who have recently moved into the area doing both buy and hold rentals and flips.
My business partner and I began spending as much time as we could in Marine Villa, day and night, to truly get a feel for the area. We discovered a vibrant working class community where investors and local residents are pouring capital and sweat equity into the housing stock to revitalize the community.
Attending local investor meetups for that ward, we learned that Marine Villa has seen a 500% increase in renovation permits year over year. While that might sound like a lot, there was a very small number of permits pulled prior to the increase, so this is a sign of new development, and not saturation among investors.
That information, coupled with our own research, was enough for us to begin looking for a deal to purchase in the neighborhood.
You might hear from other investors that it’s a bad idea, but you need to stay strong in your convictions, and trust your thesis.
Looking for a deal in a specific neighborhood can be harder than finding a deal in a larger market. Your options are limited.
To start, you can have an agent set you up with MLS alerts for every property that goes for sale in your desired neighborhood. You should also call every listing for sale and let the listing agents know that you're looking and to let you know if they have something that meets your criteria.
If those strategies aren’t working, you can call numbers for properties listed for rent by individuals and ask if they’re interested in selling. It may take a long time to find someone interested in selling this way, but it will work eventually.
Deals come up. If you stay diligent, you will find a great one.
A month after our first due diligence, an agent I knew brought us an off-market 12-plex in Marine Villa.
The deal met the 2% rule, with rents that could potentially be bumped $100 per door, from $550 to $650. This type of value-add deal in an up-and-coming neighborhood was exactly what we were looking for.
Remember the picture from earlier in the article? Another investor had already done the bare minimum to make the 12-plex habitable and was ready to sell and move on to bigger projects.
It was incredible to see the changes in progress, and we went under contract at $350,000 for the 12-plex, with current rents around $7,000 a month. The building needed a lot of work, including a new roof, sewer repairs, tuck-pointing, and some structural work, but we budgeted for it before we purchased the building.
Six months later, we've raised rents on 50% of the units as they turn over, and the building is on pace for a 30% cash-on-cash return with the potential for huge appreciation if we're right about the neighborhood.
We were a bit nervous about the deal throughout the process, but it’s turned into our best investment to date.
It’s too early to tell if Marine Villa will appreciate the way we expect it to.
Everything is pointing in that direction with the drastic increase in permits, new renovations, and rapidly improving areas to the north. If we’re right, the next few years we will allow us to refinance and use the additional equity to rapidly grow our portfolio.
If we're wrong, we still have a great, cash flowing property in a stable neighborhood that is helping us reach our goal of financial freedom. That's the beauty of the fringe strategy. High cash flow makes it easy to mitigate risk, while still providing the potential for a huge upside if the neighborhood keeps improving.
The hardest part of investing on the fringe is getting over your fears and taking action. In real estate—and in life—the best results are often found by going where others won’t and being willing to put in the work that others can’t.
Have you (or would you) try this strategy in your market? Why or why not?