Quantity vs Quality Rentals

42 Replies

Hello BP!

When first starting out using a Buy and Hold strategy and with limited capital, do you think it's better to purchase a bunch of lower priced properties in lower quality / depressed areas or spend a little bit more but have less quantity or rentals (but presumably higher quality tenants) for properties in an area that is well known for being a "good" area?

When I say "quality" i mean the quality of the neighborhood, and not necessarily the property.

For example I am looking at a property that is being short listed for 20k fully renovated (zillow estimate is 35k) but it's in a depressed area with a few rowhouses boarded up around it, but there is an existing tenant there and the rent, cap rate, and cash flow look excellent on paper. As opposed to another property in the 60-80k range that's not as nice rehab wise but is in a much better area that is known to have medical job types that would still have decent cash flow. Buying cheaper means more properties but probably the possibility of less desirable tenants in that area. 

Thoughts? Thanks in advance.

Definitely go with quality properties vs. quantity.

If you buy the low income properties, you will attract low income people at tenants.  No one else will want to live there. YOu'll have high turn over with a lot of repairs each time.  And you'll probably be chasing rents all the time unless you go with Section 8 tenants.

Contrast that with a nice house in a nice neighborhood which is filled with mostly owner occupants.  You'll get high quality tenants who can pay their own rent and they pay on time. These tenants will stay for many many years so you will have little turn over.  And when they do move out, often the property is in better condition than when they moved in.

To buy nice houses in nice neighborhoods, look for opportunities to buy with seller financing or subject to the mortgage.   You could also start with a Master Lease  to get your cash flow going.  Once you prove to the owner that you are reliable they are very likely to convert to seller financing.

You don't need a real estate agent and you don't need to use bank financing to buy your rental portfolio.  

@Alexander Merritt  

  IMHO low end rentals are only suitable for local investors that are in the landlord business and are going to scale up and own as many as they can get 100's have your own PM and maintenance and that's the ONLY way in my mind that stuff will work over any amount of time.

buy the best that you can if your just starting out.

@Alexander Merritt  

I'm a big fan of lower end rentals.  The numbers work nicely and there are almost always quality tenants to be had.  

If you believe the area your invest in is never going to change, then invest in higher end places that are going to be easy investments.  I personally believe that landlords can be great change agents in a community.  I always have nice looking places with mowed lawns, clean porches and clean houses.  The tenants pick up on this, especially if you remind them.  

If you are paying the appreciation game, you defiantly want to be at the example for the rest of the community.  

The only areas that really scare me off are major crime infested areas.  Places with shootings, rapes and frequent assaults.

@Jackie Lange  

I know there are 0% down financing options out there but I've heard they are very difficult to do, especially for someone just starting out that doesn't have a track record. What is a Master Lease? I've not heard of that before.

@Aaron Montague  

Yea it actually seems like sometimes the numbers actually work better for lower income than middle income. The example in my OP actually gives me slightly better cash flow than the house in the good area. I'm not playing the appreciation game since I think it would take literally decades for some of the areas to really appreciate significantly.

@Alexander Merritt  

There is also something to investing that I've dubbed the "headache factor."  There is an amount of money I'm willing to give up to NOT have to deal with my tenants on too regular a basis. 

In the classic "B" neighborhood vs "C" neighborhood debate, I'd probably give up a 2% monthly Cash on Cash to be in the "B" area. This % might go up a bit if both deals were north of 25% CoC. That always assumes the deal meets my minimum investing requirements. I'd love to buy lots of 20% Cash on Cash returns in A neighborhoods, but that isn't in my cards at this point. More power to you if you can :)

@Alexander Merritt   

First, think about the type of life you'd like to lead (ex. not be woken up at night, enjoy college towns, etc.).  Second, identify the type of tenant you'd like to rent to that will be commensurate to that life (ex. responsible graduate students).  Second, identify the type of property they demand (ex. well-built townhouse or duplex, with on-site laundry, amenities, built 1980 to 2010, private entrance, etc..).  Third, develop a property management model and plan to keep expenses low and revenue high.  Fourth, collect cash flow.  Fifth, quite your day job. 

 

You know the game monopoly, the little green houses you start with...those are good, yes. 

The game does not include the little boarded up houses :) 

Now what Aaron is describing could be where one of those little green houses are if you passed on the medical office worker crowd.

Lets take these 3 options below and put aside the cash flow on paper part for a sec.

Five years hold scenario:

Medical renter 70k

Aarons 40k guessing

Boarded up zone 20k 

Let say the medical center house only turns over 2 times in 5 years, no issues, one month vacant.  Its in a great location for good renters.

Aarons 3 times, no issues except a a few more months vacancies.

Boarded up zone turns over 7 times, 2 evictions, 3 trashed outs for 7k expense. 8 months vacancy. Oh I forgot about the stolen furnace and water heater when it was vacant...remember when the one next door was torched by those drug dealers, yeah it got jacked then. Add another 4k.

now add in cash flow on paper part.

thanks,

Matt

I would like to chime in and say QUALITY QUALITY QUALITY!

Having started out many years ago I thought it was better to buy cheap properties with the highest net yield return. It's been a big learning curve to find out that properties in better areas are a far wiser choice.

Would you rather have constant stress of chasing tenants for rent and evicting tenants, or a tenant who pays on time every month?

Unfortunately this is the reality of the situation.

I have properties that on paper have a ROI of 30%. These properties are in bad neighborhoods. I bought them cheap and the market rent is pretty decent. However the tenants never pay on time, I have to chase them daily, call and pester until they eventually pay. Then they stop paying altogether, I have to send one of my representatives to court and after 2 months the whole debacle is finally over and they are gone. Then I'm left with a damaged property and have to spend so much money on repairs, then look for another tenant who will probably do the same thing.

On the other hand I have properties in B grade neighborhoods with an ROI of 14% where I never hear from the tenant and their rent is never a day late. The properties in better neighborhoods also appreciate way better in value than the bad neighborhoods.

The question is, do you want passive income or headaches and stress?

@Matt R.  

Yea I mean obviously I would sacrifice higher "paper" return for actual return and less headache, but I'm just starting out in this world of RE and I don't have a large capital base to be able to buy a bunch of nice properties. Now if your going to say well you can always do creative financing and get seller financing well yea I guess I could, but I think that would be extremely difficult for me seeing as I have no track record and the seller would be less likely to do that considering that I can't demonstrate that I have a history in the business of honoring my deals. Also, the number of sellers willing to do that is extremely limited (according to the BP community) so I might get a 1-2 of those and then what.....

If I buy in the good area and use up all of my starting capital on the first house, how do I go about increasing my portfolio? Ideally I'd like to get 3-4 properties per year. That wouldn't be doable.

Don't get me wrong, i completely agree with you about better location and tenants and not having to worry about evictions, damage, late rent etc. That's the dream, right? You do minimial work and just let your rent money roll in and everything runs like clockwork.

you have the same attitude as me when I started out. Just wait for the problems, evictions and stress and your attitude might change.

 You should buy the worst house in the best area. 

@Alexander Merritt

Your original question was great and the replies you are getting from folks on here are amazing as well, but it sounds like you are trying to convince them of a decision you've already made.  You should reread all these great replies and then decide what is best for YOU.  Good luck and let everyone here know how you did.

Keep in mind, when you get ready to sell houses in low-income, el cheapo areas, your only buyer will be another investors who will want a deep discount.  In these "quantity" areas, you'll have a very hard time finding a buyer who has a down payment and can qualify for a loan .

This is an article Jack Miller wrote about the topic.

Making money from the earnings of poor people is like getting orange juice from an orange tree without any oranges on it. The same can be said of investment houses that are bought in blighted zones. Usually, only through the intervention of government in the form of low-income property improvement grants and rental subsidies can marginal properties in marginal areas be made profitable. This places a would-be investor into the same food chain as the hapless tenant who depends on both rent and government subsidies for financial survival.

Those who buy subsidized properties are gambling their financial independence upon the good will of the taxpayer who has just about reached the limits of his willingness to support these social programs. They also run the risks of high levels of regulatory pressure and litigation by virtue of their renting to legal wards who have access to free lawyers and zealous bureaucrats who see independent investors as a crop to be harvested. Thus, it does little good to garner high cash flow from these rentals only to spend it in higher maintenance, management, and legal costs.

Low income subsidized rentals may return a high gross cash flow, but their total investment value in a growing portfolio is more glitter than gold. One should look at the total return of an investment, not merely the cash flow. These factors would include the numbers of properties that can be managed efficiently; the amount of capital their acquisition consumes (which is function of their down payment and financing terms), the quality and durability of the income stream they produce both in times of inflation and recession, their fiscal independence from government subsidies, and the time one must spend puffing out fires in order to continue to function.

Last, but not least, one should consider the 'burn out' factor. When you've reached your limits in handling these properties, you'll find it difficult to sell them. There's a dearth of people with the money and inclination to cash out your investment in 'high adventure' properties. Moreover, those to whom you might sell on installment terms may not have the perseverance or skills to manage them. Ultimately you may find yourself giving back a lot of your profits just to escape

I've been debating this quite a bit as well. 

I would love to hear from people who run lower end (C or lower) rentals and have managed to run them stably. Would love to hear from @Dawn Anastasi  who I believe manages some C properties.

In Kansas City, I have seen C properties yielding 25-35% in certain cases, and B properties producing closer to 12% would people take that extra 20ish% pro forma returns for the head aches? Thoughts?

This post has been removed.

Originally posted by @Riley F. :

I've been debating this quite a bit as well. 

I would love to hear from people who run lower end (C or lower) rentals and have managed to run them stably. Would love to hear from @Dawn Anastasi who I believe manages some C properties.

In Kansas City, I have seen C properties yielding 25-35% in certain cases, and B properties producing closer to 12% would people take that extra 20ish% pro forma returns for the head aches? Thoughts?

The key is to buy quality properties and get quality tenants who will stay long-term.  I don't expect anyone to live somewhere "forever" but when they stay multiple years and leave the place decent, that's contributing to lower costs even with a vacancy.

Just had someone leave due to financial issues but they left the place in good condition and I was able to start showing it immediately.

Alexander, I feel ya. Here is the thing that jumps out. Limited capital. You got one chance to get it right. When that experienced investor finds out you bought smart it will be certianly will look more attractive than the other guy who bought wrong because it looked good on paper. What you are saying can be done just without what looks good on paper first. Dawn was mentioned here. To team up with her would solve 90% of the issues you could encounter too. Jay was on here. He has 40 years experience with hundreds of these or 1000s over 40 years. I can't imagine going against that advice. Thanks, Matt

Alexander, lets pretend you took Nat and Jays advice. In 12 months you get an equity loan on the first house. You bought right, they are expanding the medical center and it is really worth 90k now turns out. Now go get one of Aarons green houses, as luck has it, it is just around the corner from your medical center house. The other guy, who bought in the boarded up zone, has no such options. No one will finance, it is not worth more and it never really produces. It only creates negative cash flow and consistant headaches. Out of money and options, he licks his wounds and lets it go for back taxes.

 Thanks, Matt

Originally posted by @Matt R. :

Dawn was mentioned here. To team up with her would solve 90% of the issues you could encounter too.

I appreciate the kind words, but please don't point more people in my direction!  I would love to work with more people but due to time constraints I can only do so much.  Last time there was a podcast I was flooded with emails and even phone calls from people wanting to invest where I do.

Originally posted by @Dawn Anastasi :
Originally posted by @Matt Rosas:

Dawn was mentioned here. To team up with her would solve 90% of the issues you could encounter too.

I appreciate the kind words, but please don't point more people in my direction!  I would love to work with more people but due to time constraints I can only do so much.  Last time there was a podcast I was flooded with emails and even phone calls from people wanting to invest where I do.

 For sure Dawn. I meant to say someone like Dawn;)

I tend to agree with the sentiments of most of the postings here.  I believe in higher quality over the long term will ultimately yield better L....O...N...G... term returns for the reasons that @Dawn Anastasi  mentioned.  

At the end of the day, the proforma has a challenge in providing quantitative analysis in terms of possible costs.  It costs money to have a faster turn rate.  Quality properties have a longer lifespan remaining typically.  If you have a high Cap rate property that turns over often, with an occasional eviction and several hundred dollar turnover expense, your net yield is likely to drop to that of a high quality property, that MAY appreciate a bit better because of the higher quality.  

Further, higher quality properties typical have more exit strategies available. In a solid market, with a high quality SFR, you can either flip as-is to another investor, or at the other end, upgrade to flip status and retail to an end buyer.

At the end of the day, all investors have a short term and long term approach to their model.  Most build goals based upon the long term strategy, but buy based upon their short term strategy (cash flow).

Since there isnt a politically correct way to say this, I will be a bit blunt.  If you are younger, I would suggest being less focused on cashflow and more focused on asset accumulation (Rich Dad Poor Dad) at a higher grade.  Conversely, those nearing retirement, could consider the possibility of properties that can provide solid cash flow if they do not already have rentals that are paid off at that point.

To all of my clients reading this....I hope that I havent stepped on toes.  Hopefully we have covered these conversations and the best decisions for each person are met.

@Jackie Lange  

I'm not sure I necessiarly agree with that you are saying. There are plenty of properties in lower income areas which do not rely on subsidys (Section8). I do agree about the burn out factor, though.

@Dawn Anastasi  

So are you saying that even in lower income areas that if you have a "nicer" (relative term) property for that area that you will attract decent tenants who won't give you so much of a headache and will pay rent on time? I'd really love to hear more from you.

Keep in mind that I don't intend to be a slum lord. My properties will be average or slightly above average for the area and maintained properly. I think it was @Mike H.  

who said that you'll get more interest if you pick one or two things in the house and over improve them (aka granite counter top in one of the bathrooms, etc...) so that it makes the property stand out from just all of the other plain properties.

Also, being in the Baltimore area really is a challenge. After thinking about what  @Nat Chan   said a bit more I did go back and look near the hospital and found some decent properties that I could afford. But, even that area has some spots that are not so great. For instance I found a property there for 40K completely renovated (very nicely too) with the potential for $400+/month cash flow but on the same side of the street the house next door on the left hasn't been maintained and looks like a dump from the outside and then the house 2 doors down on the right side is boarded up and looks like it may have been involved in a fire. So would potential tenants look at that and think they wouldn't want to rent the property becasue of that, even with it being in a "nicer well established" neighborhood? I don't know.

Please don't misunderstand me, I definitely welcome everyone's advice and thank you all. I'm still learning a lot and I'm just trying to look at all of the options available to me.

Originally posted by @Alexander Merritt:

@Dawn Anastasi 

So are you saying that even in lower income areas that if you have a "nicer" (relative term) property for that area that you will attract decent tenants who won't give you so much of a headache and will pay rent on time? I'd really love to hear more from you.

Keep in mind that I don't intend to be a slum lord. My properties will be average or slightly above average for the area and maintained properly. I think it was @Mike H.  

who said that you'll get more interest if you pick one or two things in the house and over improve them (aka granite counter top in one of the bathrooms, etc...) so that it makes the property stand out from just all of the other plain properties.


Note that I'm not into "warzone" or "D class" properties so there's not that headache involved.  I can't even imagine what it's like to invest there.  I invest in working-class neighborhoods.  I do have some tenants that pay late, in fact I had a tenant just drop off rent yesterday with the late fee included in her money order.  But did I worry that I wasn't going to get rent this month?  No.

I just went to a property today that another landlord was trying to sell.  Oh my goodness, what a difference!  That property was run down, smelled funny, and it looked like the cheapest materials were used in there which are just going to fall apart year after year.  In properties like that, you're not going to attract quality tenants that want to stay.  You're going to attract tenants that have no place else to go, and therefore they "settle" for what they can get. 

But then you know what happens?  The landlord doesn't care, so why should they?  So they stop paying rent, especially when they start looking for something else, because they know they need to have money to live somewhere.  Then they get evicted and maybe get a free month out of it before they're gone and onto the next property.

No matter what property you have, you have to take care of it and being a slumlord can get what looks like higher than average rents, but it doesn't last.  The evictions, trash outs, and clean up over and over and over again eat up all your profits and they give you major headaches!

@William Robison  Hmmm some interesting points. Yes I'm a little bit younger so asset accumulation makes since but didn't Rich Dad Poor Dad say that property is not an Asset but rather a Liability until you own it free and clear?

I'm not completely concerned with cash flow, but IMO it is important when building a Rental portfolio. You have to be able to have enough cash flow to pay for proptery, live off, and also to reinvest back in the business.

Maybe I need to adjust my strategy a bit and do some flips to build up some capital for the rentals. It's not really what I want to do, but maybe it's a necessity to accomplish my long term goals. Thoughts?

@Alexander Merritt

Consider focusing on value when selecting your properties.

Warren Buffett teaches that price is what you pay and value is what you get.

In the case of property, the value you get is measured more broadly than in dollars of bricks and mortar.

Value property provides certain and escalating cash flow, the prospect of appreciation, worry free income, the basis for permanent friendships with the tenants you serve, pride of ownership, safety of equity and person, protection against inflation, riches in coin and experience.

If the market or a single buyer is offering you the above at a price that under values the property in whole then buy.

One should not buy property that enslaves them with its faults.

You will spend your ownership of its faults paying with your money, peace of mind and energy.

Take a patient approach and buy value.

Buffett also teaches that wealth in life can be built with as few as twenty wise financial decisions.

He does so to remind audiences that a patient search for value is the best way to spend one's time investing.

@Dawn Anastasi, @Nat Chan and others above are offering wise counsel.

Good luck,

Jonathan

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