So what\u2019s the answer to her question? Do you go for the lower-quality neighborhood (or property) and get the higher returns? Or do you go for the nicer neighborhood (or property) and settle for lower returns\u2014or half the returns in this case.<\/p>\n
If you\u2019re wondering more specifically about what return or cap rate you should aim for with a rental property, check out this\u00a0blog post<\/a>.<\/p>\n What I\u2019m going to do to help you sort through this question is to convey the exact thought process that I’d go through if someone were to directly ask me this same question. Initially, when I read this question, I had some questions go through my own mind. After that, I had specific thoughts based on my experience in this area.<\/p>\n I could spend some time telling you why I asked each of those questions, or why each of them matter. But I don\u2019t really need to. Because the bigger question here is actually: Is it worth going after higher returns on lower-end properties (or in lower-end neighborhoods)? Or is it safer to go after lower returns on nicer properties \u2014 in nicer areas?<\/p>\n I’ll get to that.<\/p>\n Now, back to the original question \u2014 for real this time!<\/p>\n Now that those initial questions are out, I can move on to whether I would chase higher returns with lower quality or stick to lower return with higher quality.<\/p>\n I\u2019m going to start my answer to this question by telling you the question that I think matters most when it comes to projected returns on an investment property (of any kind):<\/p>\n Notice I didn\u2019t ask what the cash flow or returns are. I asked, how sustainable <\/em>are they?<\/p>\n Back to this rabbit in a hat idea \u2014 anyone can tell you any numbers they want on a property. I could tell you I have a rental property to sell you and it comes with a 50 percent ROI. Call it freedom of speech or whatever you want \u2014 there\u2019s nothing illegal about completely BS-ing and trying to convince you that you can get a 50 percent ROI on my property. You, as the investor, need to be able to call my BS.<\/p>\n But I\u2019ve already talked about confirming the feasibility of the projected returns that you are given. Don\u2019t rely on estimates. Get actuals. Confirm your sources, etc. Now what I\u2019m talking about is slightly different. Instead of feasibility, I\u2019m talking about sustainability.<\/em>\u00a0And this is where the quality of the neighborhood and property really matter.<\/p>\n Even if you have the most realistic and accurate projected returns or cash flow possible, if you get one gnarly tenant in your property, or if the market you buy in collapses, you can kiss those accurate projected returns goodbye. Evictions, vacancies, damages, court costs, and rental decreases will have you crying in a corner cuddling with your checkbook that you can no longer write checks from because you\u2019re out of money. So much for that 20 percent or 10 percent return!<\/p>\n Related:<\/strong>\u00a0Your Complete Guide to Analyzing a Property in Just 10 Minutes<\/a><\/em><\/p>\n Notice I use the word quality in relation to low. Low quality. Technically, you could have a low-quality tenant who makes six figures a year and pays $3,000\/month in rent in a really nice neighborhood and in a great property. It\u2019s not always just low-income that constitutes low-quality. Trust me, I\u2019ve met some low-quality high earners in my time! And just the same, you could get the nicest, most trustworthy tenant who consistently pays on time each month for years on end, but pays very little in rent and makes very little money.<\/p>\n What has to be considered though is this: How likely are you to land low-quality tenants at the higher-end and lower-end sides of the spectrum? The reality is, for good or for bad, you are more likely to land low-quality tenants the lower in quality you go in a property or neighborhood. Therefore, the poorer the tenants will be. Your chances are lessened significantly when you go with higher-end properties and neighborhoods. Again, no guarantees one way or another, but we have to look at this realistically.<\/p>\n If you end up with a low-quality tenant, you risk expensive damages to your property, evictions, and the subsequent costs. Plus, more vacancies means a blow to your cash flow, possible lawsuits, and a heck of a lot of headaches. With low-quality properties, you are more likely to have to repair things more often, usually to the tune of a lot of money. You are also more likely to attract lower-quality tenants. Your property may lose value with time rather than appreciate; rehabs can be more expensive than expected; and your resale options down the road may be significantly hindered.<\/p>\n Do you see how all of those things could completely demolish that initially projected cash flow?<\/p>\n You have to look at it like a risk spectrum. The lower you go in quality with a property or neighborhood, the higher your chances are of running into the aforementioned issues that can be very costly. The higher you go in quality with property or neighborhood, the less the chances become.<\/p>\n So what is more worth it to you? Take on the added risk and try for the higher projected returns? Or stay a little safer and in doing so, settle for the lower projected return?<\/p>\n The answer is completely up to you.<\/p>\n And again, you could end up with terror tenants and ultimate destruction with high-end stuff too. There’s no guarantee that that will never happen. But it\u2019s about risk mitigation and the spectrum of risk we talked about.<\/p>\nFirst, the questions that ran through my head:<\/h2>\n
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<\/p>\nBut first, let’s dissect my questions, which should be asked of all potential rental properties:<\/h2>\n
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<\/p>\nHow sustainable are the projected cash flow and returns?<\/h2>\n
What two things are most likely to cause any of those things to happen?<\/h2>\n
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Some things you need to consider when answering this for yourself are:<\/h2>\n
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