Real Estate Investing Basics

Why Buying Cheap Homes Won’t Make You Money

Expertise: Mortgages & Creative Financing, Buying & Selling Houses, Personal Finance, Real Estate Investing Basics
49 Articles Written
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New real estate investors often get infatuated with the idea of the passive cash flow that real estate can bring in. So it’s not surprising when you see many new investors throw caution to the wind to chase cash flow and end up buying super cheap homes (in oftentimes questionable areas) thinking they will reach their investing goals faster.

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But this can be a big trap if you aren’t careful.

Why Not Buy Cheap?

What qualifies as a “cheap” home?

That answer differs from market to market and based on investor perspective.

For the purpose of this exercise, let’s entertain the scenario I often see in the forums, where a new investor posts they have bought a Midwest market home for $40,000 that rents for $700.

But buying cheap homes often violates the four tenets of conservative investing: capital preservation, cash flow, appreciation, and tax benefits.

Cheap houses tend to:

  1. Be in areas of town that are most likely on the decline rather in the path of progress, impacting your tenant options, ability to protect your capital, and overall appreciation possibilities.
  2. Have higher tenant turns and higher turn costs due to lower pride of ownership, thus impacting your cash flow (the very reason you might have bought the cheap home to begin with!).
  3. Have higher CapEx/maintenance costs in relation to the rents, again impacting your cash flow. It’s not like a roof or water heater costs any less because it is a less-expensive home, so you have to set aside more of your rent to prepare for these costs, thus eating into the cash flow you thought you were getting.
  4. Be harder to insure for a reasonable cost, since the cost to replace the property is often much higher than the actual value of the property. If you can get lending, the home is taking up a valuable lending spot, and the tenant is paying down less debt for you.
  5. Have fewer exit strategies due to fewer qualified buyers at that price point, thus putting your initial capital at risk if you can’t sell the property.
  6. Make it harder (or impossible) to secure lending, since banks have a minimum up loan amount they will underwrite. As a result, when you buy all-cash this can slow your velocity of money and expose your capital to greater risk by owning the property all in cash.
  7. Have lower depreciation, impacting your ability to use one of the most powerful tools of real estate to keep your cash flow tax-free, especially if you purchased all-cash.

Again, what qualifies as a "cheap house" is all relative. For my investing strategy, I like C+ to B-class homes, in stable or desirable areas, that have an ARV of $100,000+. For another investor, my property may be a "cheap house!"

Related: We’ve Done the Math: You Can’t Make Money on $30,000 Houses. Here’s Why…

What To Do Instead

Before you commit to this strategy of investing, step back and take a moment to follow the steps below to build a comprehensive investing plan.

  1. Take a deep introspective look to understand:
    • Your true investing goals. Do you need cash flow, equity growth, or a balanced approach of both?
    • What investing strategies line up with your investing goals?
    • What kind of time can you dedicate to your investing plan? Just like any business, it can take quite a bit of work to get your real estate plan off the ground.
  2. Research your markets/submarkets that will tip the investing cards in your favor and that you can afford to invest in. Look for markets where there is:
    • Population growth
    • Job growth
    • Job diversity
    • Income growth
    • Affordability (asset prices and rents)
  3. Once you have narrowed your market and submarkets, pick two to three to do a deep dive analysis of the various assets that meet your investing goals.

These three steps are the three toughest steps to get right in real estate and are the steps that many investors shortcut. Once you have these three steps dialed in, then you are off to the races to set up your team, build your deal funnel, and start making your deals happen.

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

Wrapping Up

This isn’t an exhaustive list of all the steps you need to get started to investing in real estate, but it is a great start to building a plan to keep you out of one of the most common pitfalls new investors face: the temptation to buy super cheap investments.

Have you bought what could have been considered a “cheap” house?

Tell us how it went for you in the comments.

Whitney is a real estate investor and personal finance trainer. After purchasing her first rental in 2002 and hitting a home run, she nearly lost it all on her second deal. So she took control and figured out how to invest in real estate the right way. In 2018, she founded ASH Wealth and the Investor Accelerator Mastermind. In the Accelerator, she'll show you exactly how she built her portfolio: $500M+ in real estate assets, including 5,000+ residential units (MF, MHP, SFR, and assisted living), 1,430+ self-storage units across seven states, and over $3M in residential fix and flip real estate. (Though don’t tell anyone, BRRRR investing is still one of her favorite ways to invest!) She has been featured on BiggerPockets Real Estate Podcast episode #340, BiggerPockets Rookie Show episode #29, BestEver Podcast, The InvestHer Show, Investing for Good Podcast, and more!
    Steve Rozenberg Specialist from Houston, TX
    Replied about 1 month ago
    Great Article, I almost went bankrupt buying the wrong properties. Which for me were low income homes. I had the wrong business model (passive investor) concept around these homes and I was a disaster. Unfortunately it was not till the 35th home that I figured this out.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied about 1 month ago
    Ouch! Sorry to hear that, Steve. Here's to a speedy recovery!
    Jerry W. Investor from Thermopolis, Wyoming
    Replied about 1 month ago
    Nice in theory, but in my market you simply cannot cash flow a $100k property. At most you would get $800 per month rent. It isn't a great ratio, but a $60K house that rents for $650 is about as good as you get. Your model may be true in metro areas, but rural areas dont have many rentals bringing in over $1k a month. I briefly rented out my prior residence and got $1,100 per month, but it is easily a $180K house, It simply doesn't work to do higher end houses in my market or any in my area.
    Tyler D.
    Replied 6 days ago
    @Jerry, Have you taken a look at total returns over the long term as opposed to cashflow right now?
    Tony Darcy
    Replied about 1 month ago
    I agree. I always want a cash-flow positive property as otherwise it becomes much harder to borrow money to pay for the next one. I'm not necessarily saying to always go for the absolute cheapest property you can find, mainly for the reasons pointed out in this article, but I still want it to be cash-flow positive, so it increases my borrowing power, not decreases it.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied about 1 month ago
    "Cheap is relative", Jerry. Cheap in my area is $300K!
    James Dixon
    Replied about 1 month ago
    I did purchase a duplex in 08 at an auction for 3k cash. Has it taught me some things yes.. Have I had high turn over yes. Have I beaten the stock by the over price of the stock market yes. The value of the home currently is 48k. I have had many offers to purchase the home without even listing the property.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied about 1 month ago
    Good for you, James! Have you fully crunched the numbers to figure your cash returns, and return on your time? I'd be interested to know how both look!
    Marcus House Rental Property Investor from Woodbridge, VA
    Replied 29 days ago
    I would love to see those numbers as well James.
    Joshua King
    Replied about 1 month ago
    Great article. I like the rule "Don't invest in a place that you wouldn't live in yourself." It keeps me honest.
    Nicki Shelton from Fort Worth, TX
    Replied 20 days ago
    That's great advice!
    Rick Grubbs Rental Property Investor from Salisbury, NC
    Replied about 1 month ago
    At the beginning of your real estate career for most people time is more plentiful than money. Buying lower end houses allow the newbie to go ahead and get in the game sooner and spend time learning how to fix stuff and manage tenants. These are valuable skills you will need further down the road to monitor and manage others who will do those jobs for you as you buy better properties and spend less time with your rentals.
    Tyler D.
    Replied 6 days ago
    There are plenty of people for who the opposite is true. My time is incredibly valuable, and I certainly don't have time to inspect, buy and manage dozens of $50k properties.
    DWAYNE W. from Severn, Maryland
    Replied 25 days ago
    ABSOLUTELY!!! Sometimes we have to respect the process of growth and the evolution of expertise. That sometimes means going through challenges so that you learn more about yourself than you knew before.
    Joseph Cacciapaglia Real Estate Agent from San Antonio, TX
    Replied about 1 month ago
    Great article. I see a lot of new investors fall into the "cheap home" trap. They get caught up in many of the arbitrary rules of thumb that push them into decisions that don't actually make sense. Most of my successful clients are much more focused on the quality of the property and the neighborhood, which allows them to make much better long term investment decisions.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied about 1 month ago
    Very true, Joseph. I almost fell into that trap too. I had one turnkey operator actually ask me why I wouldn't look at his higher-end homes. He explained the rationale and that's when it clicked for me! Granted he made more money on the transaction... and so did I as those home experienced far less issues and appreciated very well.
    Elliott Kleiman
    Replied about 1 month ago
    Hi Whitney, thanks for this great article. I'm curious if there is a rental business model that IS profitable with cheaper homes? What does that look like? There are individuals and groups of investors buying dozens or even hundreds of cheap homes so seemingly it can work, right?
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied 28 days ago
    Scale could work. However, I would ensure all units are rehabbed top to bottom to prevent any capex surprises. Also, you have to consider resale value. You still may be giving up one of the profit centers of real estate. In the end, know your goals!
    Sean Sloop Real Estate Agent from Grand Rapids, MI
    Replied 29 days ago
    Personally speaking, I think at scale this model would work. If you have just a couple properties, the next big capex will wipe out your cashflow. At scale, the cashflow from others will cover you. Also, buying cash or planning to pay off early may fit this strategy better. Just my 2 cents.
    Wale Lawal Realtor | Buy & Hold Investor from Houston, TX
    Replied about 1 month ago
    Great article Whitney, I agree with your point of view. For the new investors, it's still better to start than to never start because the investor is trying to avoid some issues. I am a strong proponent of getting started and figure it out along the way. For passive and experience investors, are more conservative and don't have much time so they take all the points you stated into consideration before they make an offer on any property. I have seen this with most of my experience clients as well. Thank you for reminding us.
    Angel Castillo New to Real Estate from Norwalk, CA
    Replied 30 days ago
    Hello if y’all had 30k and wanted to invest in Houston Texas ... how would y’all approach .. I’m looking to buy and hold rental sfh ... (long term) cash flow is main focus
    Peter Guerra from Modesto, California
    Replied 30 days ago
    Well I say diversify you real estate ....have equity growth properties and have cheap cash flowing cow's ..some of the best rental properties I have are my cheap out of state rentals ,,,it has been 17+ years and they bring in the cash and while that is taking place I have invested in new construction here in California and I have had tremendous growth and to give you an example I have gained about 150k in the last year just on my new construction owner occupied purchase that took 7 months to build as I was one of the 1st ones to buy in the dirt phase ...they just kept going up....every needs a roof over their head.....give it to a property manger so they can deal with tenants but cash flow is king and as far as the lady saying don't buy unless your going to live there ....I agree only on the properties I am going to occupy or for equity growth ,,,but as far as my cheap cash-flowers ....easy to get into ....if you have a vacancy it would be paid off or piti would be so small that should not affect you wallet or purse may I say....anyway this has worked for me for over 17 years
    Susan Maneck Investor from Jackson, Mississippi
    Replied 30 days ago
    You can do well with cheap properties in Mississippi. No, they don't appreciate that well but if you can rent a 35K house for 850 how long does it take to get your money back?
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied 28 days ago
    Susan, that is a strategy! And, as stated, cheap is relative to the area. Very different from "inexpensive". If that $35K home is in a good area of town, will hold value, and can attract a good tenant, then that falls in "inexpensive"... not cheap.
    Marcus House Rental Property Investor from Woodbridge, VA
    Replied 29 days ago
    Exactly Susan.
    Tom Mattinson Investor from Amherst, NOVA SCOTIA
    Replied 29 days ago
    I hope you stick to your theories of investing and that it works for you. This type of mindset typically comes from "leg up" investors who started with a trust fund or something similar. The idea of buying cheaper houses is normally bigger amount the "self built" crowd. I would like to take the time at some point to respond to this post with the level of detail that it deserves but for now I just want to say two things. First. You are wrong. Second. Just because you are wrong does not mean it is wrong for you. Some investors don't have the skill set or internal ambition to drive them into the market let alone through one into the next. You need to understand that people invest in what they know and can invest in. Some of those people buying cheap homes are buying cheap homes as buying nice homes or multis in nice areas is just not an option.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied 28 days ago
    How interesting you feel that I am a "trust fund" investor that has a "leg up". Quite the contrary. My entire portfolio is built from value-add investing, being scrappy, and using other people's money to create win-wins. Perhaps, like others here, you are confusing "cheap" with inexpensive. I mostly buy B/C homes in solid areas of town that are $80-150K and attract quality working-class tenants. I don't invest in the larger class A homes... that asset class has downsides as well. Best of luck.
    Elden R Gillard II
    Replied 26 days ago
    I am new to this, and just want to ask... What is the criteria in rating a home A/B/C, etc?
    Sean Sloop Real Estate Agent from Grand Rapids, MI
    Replied 29 days ago
    Some midwest market, cheap homes are not only bad areas! In Lansing, MI, you can find homes in C+ to B areas under $100000. I think cheap homes can work at scale or if the plan is to buy cash/paid off homes. I shoot for around 900 in rent per door to make sure there is enough cashflow to cover expenses as they come up. Definitely understand the other side though! I also invest in a more expensive market to get some diversification.
    Whitney Hutten Rental Property Investor from Boulder, CO
    Replied 28 days ago
    Agreed, Sean! I invest in those homes (have a whole portfolio of them). I wouldn't call that cheap either. That's inexpensive. I bet you though there are some $40K homes in rougher areas of town that you wouldn't touch though...
    Johnny M. Investor from Elk Grove, California
    Replied 29 days ago
    My experience in investing in “cheap” homes in the midwest over the past 5yrs has been a learning experience as well as profitable. Yes, I’ve had my fair share of tenants not paying rent at times, but overall, I cash flow every property, had some to little appreciation (it is the midwest afterall), and still able to have tax benefits. One of the crucial criterias I’ve learned to have is EXCELLENT property management when investing out of state. It starts with quality screening and a strict, but reasonable property manager. My main priority when I first began investing was cash flowing properties. I’ve analyzed buying properties over $100k with market rents, having debt service as well as other expenses doesn’t yield me as high as a return as my current investing strategies.
    Evan Tom Investor from Fullerton, CA
    Replied 24 days ago
    Hi Johnny, What are some tips you would give someone looking to invest Out of State in terms of finding property management. I've been reading a ton of Long distance investing books and it all seems to boil down to finding the right PM.
    David Song Real Estate Broker from Redwood City, CA
    Replied 27 days ago
    Great article. It’s a little contra intuitive, but it’s true. Really dirt cheap houses can be viewed as mobile home. Their underlying land has no value. The cost to maintain it is the same as a million dollar house, but their rental return and appreciation return is miserable. The rent may seem to be high relative to purchase price, but very low relative to its maintenance cost. Any cap expense will ruin the whole year rental income. Any turnover maintenance will ruin another few month rent. The main problem with these type of properties is their location. Very bad location.
    Karl B. Rental Property Investor from Columbia, MO
    Replied 26 days ago
    My first investment property was a 4-plex I paid 79K for that pays me $2035 monthly. My second investment property is a duplex I paid 45K for (and put an additional 3K into) that pays me $1370 monthly. I'll buy whatever as long as I'm happy with the cash flow - whether cheap or 'expensive'.
    Paul Moore Investor from Lynchburg, VA
    Replied 26 days ago
    Whitney: You have a gift... for saying a lot in a few words. Great job! I agree with your conclusions and think this applies to apartments and other commercial asset classes.
    Arlan Potter Investor/Accountant/Builder from Meno, Oklahoma
    Replied 26 days ago
    I started 18 years ago buying cheap properties. I mean real cheap houses. Most not on the good side of town, Managed ourselves. Ended up with I think 105 Doors. Years of learning, aggravation, chasing renters, and paying down debts. After 18 years the wife and I said we are not doing this for 18 more. We started selling first all the revolving door rentals, ones that are hard to keep rented and keep getting tore up. With the 22 houses sold, All our duplexes sold and 3 houses under contract, along with our 32 unit apartment under contract, we will be out of debt in a few months, with 26 paid for rentals, 2 commercial retail buildings, a 12 unit storage facility, and 3 paid for farms-with cows and calves. Some would say why sell now? We are seeing that the market right now is good to sell rentals. Lots of buyers out there. Lots of newbies that need a hard knocks education.
    Wale Lawal Realtor | Buy & Hold Investor from Houston, TX
    Replied 19 days ago
    Great point and strategy. Yes, it's a sellers market right now all over the country. Goodluck with the sales of your 32-units.
    Stan Smith
    Replied 23 days ago
    I bought 100k house and putting 60k into it. it was built in 1930s . the area is near restaurants and business
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 23 days ago
    Paging Ben Leybovich...
    Siddhartha Gandhi from New York City / Space Coast FL
    Replied 21 days ago
    Cheap rentals get cheap tenants. Cheap tenants cause problems.
    Nicki Shelton from Fort Worth, TX
    Replied 20 days ago
    I'm new to real estate and though it would be a good idea to buy a cheaper house but after reading this article has brought many good points I never would of thought of. So thank you. I will keep looking for our first property.
    Andrew Watson Rental Property Investor from Atlanta, GA
    Replied 20 days ago
    With respect, saying that ‘buying cheap homes won’t make you money” is rather definitive and should probably be preceeded by “in my personal experience”. There are some notable points in the article that should be considered before jumping into this market: traditional bank financing is unlikely, you may experience heavier turnover (though it has not been our experience), and exit strategies may be more limited (we rarely sell, so I can’t really comment). On the other hand, here are a few arguments from someone who buys cheap houses (<$40K, all in, after renovation) and rents them for $700-$800. First, cheap houses are, in fact, cheaper to maintain in many cases. One big example is the roof. A roof on a home in Atlanta might be $10,000+, but a roof on our rental homes south of Atlanta are $4,000, with architectural shingles – simple rooflines, single story, and about 1,000 s.f. HVACs are cheaper because the houses are smaller. Sure, toilets still clog, but we only have one per house. To name just a few. Second, we have no trouble insuring our homes for a fair price / valuation. Our homes are about $550 to insure, per year. And our property taxes average $500…per year. Compare that to a $150K rental in metro Atlanta…now that puts a dent in your cash flow. No, our homes are not in the ‘path of progress’, and they are not in classy neighborhoods, but there is high demand for nice, affordable homes from responsible renters. Last, and more of a philosophical question: if we only buy houses that we would live in, who is going to buy houses to rent to people who don’t make a lot of money - people like teachers, firefighters, police, retirees? To be clear, I’m not advocating that a new investor in Bainbridge Island, WA buy $40K homes with abandon in central Georgia. We spent years researching our markets. We manage our properties from 90 miles away. We do not use property management companies. We take dumpy homes and turn them into the nicest homes in the neighborhood, then rent them to decent people. We build / renovate nice homes because nice homes attract good people who will take care of them. The bottom line: In our case, buying cheap homes does, in fact, make money…very good money. Some of our homes are financed with private money (8 year mortgages, paying 9% interest) and those homes also make good money, even after debt service.