The quality of your renters determines the quality of your returns.
In over 15 years of landlording, I’ve found that to be true time and time again. And while there are plenty of good Section 8 tenants out there, my experience has been that it’s just plain harder to find reliable, high-credit, low-impact, respectful tenants in lower-income neighborhoods.
Many people instinctively object to that statement out of political reflex. To them I have a simple reply: “Go put hundreds of thousands of your own dollars in lower-income housing. Once you’ve accrued firsthand experience with it, we’ll compare notes.”
(The comments on this article should be fun!)
The hardest lessons I’ve learned as a real estate investor came from investing in hard neighborhoods. Many of those lessons I wish I’d known when I first started out—they would have saved me tens of thousands of dollars in losses.
I no longer invest in Section 8 rentals because of those lessons. Here are the reasons why.
1. Annual Inspection
Section 8 requires an annual inspection of every participating property. And every single year, the inspector will find five to 10 items to list.
Why? Because it’s their job to list something. It proves to their supervisors that they’re actually visiting and inspecting every property on their list.
This is all well and good for keeping the bureaucratic cogs turning, but that doesn’t make it any more fair to you as the property owner.
I had a property where I’d spend $2,000-$3,000 on inspection-related repairs like clockwork every single year. Occasionally the inspector would point out a useful property repair or update. Most of the repairs were invented as busywork.
That $2,000-$3,000/year? That was my profit margin. Gone, every single year. I never earned a profit on that particular property.
2. Eviction Delays
Section 8 tenants are notoriously difficult to evict.
When they fail to pay their portion of the rent, or violate the lease in some other way, Section 8 requires extra steps from you to file and complete the eviction process. It varies by jurisdiction, but it could mean extra notice given, extra forms completed, an extra hearing, or an extra review.
I’ve had evictions take 11 months before. Meanwhile, the tenant laughed all the way to the bank with nearly a year of free rent.
3. Initial Renting Delays
Eviction isn’t the only thing that takes longer when you’re dealing with a bureaucratic machine like Section 8.
You can also expect a delay in renting to the tenant, due to Section 8’s initial inspection—during which they may issue mandatory repairs to you before allowing the tenant to move in.
Section 8 must approve the rental agreement and all other leasing paperwork. Even once they (eventually) give you and the renters the green light, you can still expect to wait up to 60 days for the first month’s rent check.
Nothing happens fast with Section 8.
4. Financing Challenges
At purchase prices below $75,000 or even $100,000, it’s difficult to get financing.
Lenders earn nearly all their revenues as a percentage of the loan amount. A $50,000 loan comes with the same amount of work as a $500,000 loan, but the latter brings in 10 times as much revenue.
Most investment property lenders don’t even consider loans below $75,000. And redlining laws notwithstanding, you better believe that underwriters pay closer attention to properties in lower-end neighborhoods.
I should know—I started my career working at a mortgage lender. From the lender’s perspective, these loans involve more work, less revenue, and higher risk. It’s a losing combination from their standpoint.
5. Higher-Risk Tenants
Get indignant if you want. But it’s true: lower-income tenants tend to be higher-risk tenants.
That risk comes in several forms. One of them is the risk of rent defaults; even the Federal Reserve reluctantly concedes that there’s a correlation between income level and credit history. And beyond lower average credit scores, lower-income renters tend to have less in savings to weather emergencies, as well.
Read: higher risk.
But defaulting on the rent isn’t the only risk. My experience has been that lower-income renters tend to be harder on their homes than middle- and upper-income tenants. Less gentle, less respectful of the properties. And that goes doubly for Section 8 tenants, who have less of their own skin in the game.
Critics can accuse me of generalizing. Yes, I am—because that’s the only way to discuss broad trends among millions of people.
6. Lower-End Neighborhoods Come with Other Risks, Too
The tenants themselves aren’t the only risk in lower-end neighborhoods.
I’ve had excellent low-income tenants living in a rough neighborhood, and do you know what they did? They moved out as soon as they could afford it. I don’t blame them.
They complained about crime, which I sympathized with but could do nothing about. It caused high turnover rates, and as experienced landlords know, turnovers are the most labor-intensive and expensive point in the tenancy cycle.
Higher turnovers mean more work and lower returns as a landlord.
And the renters weren’t the only victims of crime—my properties got vandalized, broken into, and stolen from regularly. The most common incident involved dismantling the central air conditioning condenser to steal the copper tubing inside. That was $3,000 down the proverbial drain, every single time, because insurance wouldn’t cover theft in these neighborhoods.
I then installed steel cages over the condensers. Local lowlifes sawed through them and stole the copper anyway. I eventually stopped bothering to install central air conditioning in those neighborhoods.
In the end, I stopped investing in them altogether.
7. People Call You a Slumlord
The same people who lament the lack of affordable housing in one breath turn around and call you a slumlord in the next when you buy lower-end housing. Then they try to pass increasingly stringent regulations against you—all without ever investing a dollar of their own in affordable housing.
It’s a lose-lose proposition for real estate investors. This is precisely why there’s a dearth of affordable housing in the US: it’s neither economically viable nor politically viable for investors.
In my youth, I had grand visions of going into low-income neighborhoods and improving them, with beautiful renovations and amenities like central air conditioning. I then got pecked to death by inspectors, ever more stringent anti-landlord laws, and activists calling me a slumlord, even as I lost more and more money from break-ins, turnovers, mandatory inspections, and registration fees.
If activists want more affordable housing, they can invest their own money.
If You Must Invest in Section 8 Rentals…
New investors are drawn to lower-end rentals because they’re cheaper, and therefore easier to buy when you’re just starting out.
Resist the temptation. They may cost less to buy and look like they have better cash flow numbers on paper, but they come with hidden costs like higher turnover rates, higher property damage and repair costs, higher vacancy rates, and higher eviction rates.
But if you dismiss everything I outlined above for political reasons, stand by your principles by investing your own money in Section 8 rentals. Just make sure you protect yourself better than I did by following these tips.
Make Sure the Numbers Work for Cash Tenants, Too
Investors used to love Section 8 rentals because Section 8 sometimes paid higher-than-market rents.
While that’s largely changed in recent years, in some districts it still happens. Regardless, you can’t count on those higher rents.
When you run the cash flow numbers, make sure they work even if you rent to a cash tenant paying market rent.
Screen Applicants Aggressively
In higher-risk neighborhoods, you need to be extra thorough when screening tenants.
Beyond screening reports, talk to current and former landlords, and verify that they are, in fact, the applicant’s landlord. Getting your buddy to pose as your landlord is an old trick, and one that applicants have tried on me before in lower-income neighborhoods.
Importantly, also inspect their current home, with as little notice as possible. You want to see how they live day-to-day, how well they keep their home on an average day.
Because that’s how they’ll treat your property.
Tenant-Proof Your Property
The more indestructible you can make your property, the less damage your tenants will do.
Do everything in your power to tenant-proof the property, from replacing carpets with invincible luxury vinyl tile to coating the walls with glossy, wipe-clean paint.
Collect the Highest Security Deposit You Can
No matter how well you tenant-proof the property, you still risk damage.
Protect yourself and your property by collecting as much of a security deposit as possible.
Inspect the Unit Every 6 Months
By conducting semi-annual inspections, you achieve several goals.
First, you can spot needed repairs and other property issues early. Second, you can spot lease violations and nip them in the bud.
But perhaps most importantly, you send a loud, clear message to your tenants that you care about the property, that you’re paying attention, and that you enforce the lease rules.
Sound like a lot of work? It is. Welcome to landlording.
Don’t Drag Your Feet with Evictions
If the tenants do violate the lease, send an official eviction warning notice immediately.
It reinforces the message that you do not tolerate violations, and that the rent should be their first financial priority, not their last. Tenants will push your boundaries, and it’s your job as a landlord to defend them if you want your tenants to respect them.
Besides, as outlined above, the eviction process takes a long time with Section 8 tenants. They’ll have ample opportunities to bring the rent current or fix the violation before the eventual put-out date.
There are better ways to buy real estate with little money down than buying Section 8 properties in low-end neighborhoods.
I can’t tell you how many people have spit personal accusations at me over my arguments above. For some reason, people get very personal over it. Yet they never dispute the argument itself with, “I disagree because I’ve found Section 8 properties a sound investment for these reasons.” Instead they try to silence opposing opinions by attacking the dissenter: “People like you are the reason there’s not enough affordable housing in this country.”
I don’t invest in Section 8 properties anymore. I don’t recommend that you do either, unless you go out of your way to learn the strange world of low-end real estate investing. It’s a unique niche, and one that most investors find they don’t have the stomach for.
But however you choose to invest, the most important point is that you protect yourself and your investment.
Disagree? I’m all ears to opposing opinions. Just keep your arguments grounded in economic and investing terms, not political or personal terms!
Let’s talk in the comment section below!