When Low Purchase price doesn't make a great Investment option

When Low Purchase price doesn't make a great Investment option

Real Estate Investor · Los Gatos, CA · Member since 2014 · 226 posts · 89 votes

In the today's real estate markets, investors are finding an abundance of distressed inventory and in some cases for prices that are 10% of the "replacement" cost of the property.

After quickly glancing at the rents on Craigslist you might be tempted to jump off your chair and go grab a handful of these $10,000 priced 3 Bedroom Single Family houses and setup your passive cash flow machine and roll in the dough. Well, not so fast!

There are several markets in the US that exhibit such behavior, let's pick for example South Chicago where the local economy is plummeting and rising crime rates are pushing small cities into bankruptcy depressing the real estate prices even further. So you set eyes on a great foreclosure listed at $25,000 a quick grab and go 3 Bedroom SFH 1000 sqft in Harvey, IL. You quickly check the rents in the area and see that you can fetch easily $1000-$1200/mo, WOW what a Steal you might think. I should buy the whole block!

Well, it turns out that there are several issues that make this deal go awry extremely fast. First rule of thumb for the novice real estate investor who is looking to build a passive revenue flow is to never buy properties in an area you don't want to live in yourself, no matter what. So you start wondering, ok, so what's the neighborhood like in there? One option, get in your car and do a drive by, see what it looks like or save yourself the time and grab a rent & neighborhood report from [REMOVED]. Let's walk though a real case scenario:

The following property is listed on Zillow for sale:

You also notice the rentals listed across the street for $1k to $1.4k and your heart starts jumping. What you don't know yet, is far worse. Let's take this rental and analyze it:

You examine the estimated rent section and notice the estimated rent to be about what you thought or $1,180/mo. Also the comparables sustain the price as well. First thing that you should be worried is the Renter density of 42% as well as the Vacancy rate of 18%. You want the Renter density to be low in the 25% range and also a vacancy rate under 10%. The two things you observe already spell trouble meaning you might have a long time to fill up that vacancy. Let's move on and assess the trends in the area, you observe from the chart that the rent is pretty much stable for the past 12 months, a good sign definitely.

Next you take a look at "Who lives on the block", another major piece of the puzzle:

While we're not going to make any comments, you will notice there is a strong correlation between Household income and Highest education attained and also you will use this information to correlate the Crime rate available in the next 2 widgets in the report:

You notice an almost four times than nation average in the crime rate, including 10 murders and 9 rapes alone in the past 12 months and also more than double the amount Burglary and Thefts. That can't be good for a city with a population of about 25,000 you think, I don't want to have my property vandalized while it's on the market awaiting for a tenant.

With that in mind you move on to evaluate the quality of the nearby schools, which has a high correlation in your decision:

You definitely notice the school quality is at the bottom of the barrel. This again can't be good.

Putting together all you have learned in last 5 minutes you might decide that even though the price is amazing and you will make a Rent-to-Price rate north of 5%, you will most likely have troubles keeping the property rented even even worse collect rents and securing your property against burglary while vacant.

I hope this helped you putting a line in your due diligence todo list!

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Crystal SmithPro Member
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Real Estate Broker · Chicago, IL · Member since 2014 · 2k+ posts · 1k+ votes
11y
Originally posted by @Bogdan Cirlig:

Well, it turns out that there are several issues that make this deal go awry extremely fast. First rule of thumb for the novice real estate investor who is looking to build a passive revenue flow is to never buy properties in an area you don't want to live in yourself, no matter what. 

Totally disagree w/ this advice.  Let the numbers do the talking on whether you invest in a deal or not, not the emotions of whether you would want to live there yourself.  

See this reply in the discussion

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    11y

    @Bogdan Cirlig 

     Not disputing your experience's  but just saying all of south Chicago is like this is not correct in my personal experience's.  But again you can go to every major metro area from Chicago to  Detroit, philly, Baltimore, Cleveland, Memphis,, Atlanta, KC, St Louis ( some fire sales going on there now) etc etc. and find blocks and blocks of board ups.  

    And we saw a little of this on the West coast as well.. back in the 07 to 2010... boarded up new construction in the central valley and inland empire.. projects in Vegas 1/4 started and stopped and still sitting there derelict...

    Its just in these bigger cities out east that you see this gross obsolesce of the SFR product.

  • Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    11y

    Good shoes are not cheap. Here is a recent pic of a bullet hole in a low price rental. 

  • Real Estate Investor · Waterford, CT · Member since 2012 · 6 posts · 2 votes
    11y

    I would say it is good to do your due diligence when investing in any area. The riskier the investment the bigger the reward, not for someone inexperienced in  questionable neighborhoods. 

  • Crystal SmithPro Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2014 · 2k+ posts · 1k+ votes
    11y

    @Bogdan Cirlig I was going to stop responding to this thread, then I saw your response on lenders not supporting "South Chicago";  drank some Xmas egg nog & decided to respond but it looks like I was beaten to the punch by @Jay Hinrichs regarding bank redlining. Private lenders/HML operate under different rules & we know some local HMLS that won't do deals in Harvey, Chicago Heights & Hazelcrest, but the rest of the South Suburbs to the Indian border is fair game.

    Regarding the original post & what data to use to support a low price purchase. We purchase property both to flip & to hold. We'll pursue purchasing a SFR for a flip if we can find enough sold comparables to support our target $ margin. (We'll also look @ the DOM) We'll generally use the same criteria when we're evaluating a SFR for a hold. If there are enough sold comparables that support people purchasing for home ownership then we can also consider the property for a hold. We can use this criteria no matter price point of the property.

  • Real Estate Consultant · Chicago, IL · Member since 2014 · 720 posts · 439 votes
    11y

    @Chris Martin, as a Realtor I can't comment on a neighborhood if it's bad or not. I can't talk about the crime rate and a lot of other things. I can refer a website for the buyers to do their own research and I always advice my clients to drive the neighborhoods they are interested in, this way they can figure out them-self.  Declaring a neighborhood "bad" it's discriminatory if a licensed broker says it ...

    What defines a neighborhood for me is not what defines it for you or any other RE buyer. Everyone has their own ideas about what's good or bad. 

    When a buyer hires me to buy a home to occupy it, the initial interview is different than the questions I ask an investor. The goals of these two buyers are different. 

    I am the Real Estate expert, meaning I know prices, areas, the process and how to negotiate the best deal for my clients whomever they are: buyers or sellers. 

    Hope that makes sense to you. 

  • Real Estate Investor · Chicago, IL · Member since 2014 · 33 posts · 58 votes
    11y

    That jives with what I see too. Although it may not be politically/legally correct, banks don't want to lend to "those" people or invest in "those" neighborhoods*. So the cheap houses are being bought by landlords, turning once thriving neighborhoods into rental communities. Without doubt, investing in this niche can be extremely profitable. Without doubt, if you're an upper middle  class neophyte investor in California, it will require hundreds of hours and thousands of dollars to ascend the learning curve needed to achieve those profits. Depending on your talent, access to capital, highest and best use of your time, opportunity cost, etc. it may or may not be worth the effort/expense.

    A couple of folks have mentioned that the requisite skill set doesn't vary by geography. I've also found that to be the case based on my experience dealing with tenants in FL, GA, and IL. For those that are interested in pursuing this niche, I suggest not picking an area 1200 miles from home. Find a working class area within a few hours drive of where you live and hone your skills there.

    *those- refers to socioeconomic status, not explicitly racial 

  • Real Estate Investor · Los Angeles, CA · Member since 2014 · 237 posts · 67 votes
    11y
    Originally posted by @Bogdan Cirlig:

     Where did you get these graphs?

  • Rental Property Investor · Douglas County, MO · Member since 2014 · 1k+ posts · 1k+ votes
    11y

    @Lumi Ispas

    I can understand that telling a client that a neighborhood is "bad" would be prohibited, but if a client asks what the crime rate is, you can't answer? That doesn't make sense.

  • Real Estate Consultant · Chicago, IL · Member since 2014 · 720 posts · 439 votes
    11y

    @Sylvia B. that's right. 

    Answering those questions is the best way for an agent to loose his license, pay hefty fees and even go to jail. The law is the law. 

    All neighborhoods have crime. There is absolutely no neighborhood with 0 crime, however some are petty crimes, while others are violent, and in some neighborhoods the crime percentage is up to 400% higher than others. 

    As an agent, I always advice the clients to drive the neighborhood at peak traffic time, so this way they can see exactly who lives in the neighborhood and get answers on their own. Also, I can advice them to go on a number of websites that answer the questions they have much better than I can.

    City-data.com is a great example of compiled data, that shows criminality rate, population density, percentage of tenants vs owners, schools, median income, etc.

    I can understand how you will get frustrated for not getting straight answers to this questions, and as an investor, when calling on a new market, I always ask which neighborhoods the broker thinks are up and coming. That's a legal question...

    Hope this explanation helps.

  • Real Estate Investor · Los Gatos, CA · Member since 2014 · 226 posts · 89 votes
    11y
    Originally posted by @Jerry Poon:
    Originally posted by @Bogdan Cirlig:

     Where did you get these graphs?

     Follow the link in my sig. Can't post directly as per forum rules.

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    11y

    @Jerry Poon 

      Looks like Bodgan created these and probably sells them would be my guess... now that's just a WAG

  • Real Estate Investor · Los Gatos, CA · Member since 2014 · 226 posts · 89 votes
    11y
    Originally posted by @Jay Hinrichs:

    @Jerry Poon 

      Looks like Bodgan created these and probably sells them would be my guess... now that's just a WAG

    Oh definitely it is me. I checked with moderators and they advised me to post the content of our blog directly in here and remove any self promo links. I posted it for the face value of the info, being in "starting out" category. But you are right, the report is an case study for newbies. Another great example is, Katy, TX area: AMAZING to pick up cash flowing properties in the $100k range with $1,300/mo rent. I plan to write specifically about good investment areas as I come across them and run them through the "grinder". If you'd like to highlight any areas in the US, send me a private message. Disclaimer: Not to be interpreted as investment advice. I'm not licensed to provide any advice.

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    11y

    @Bogdan Cirlig 

      No license necessary to sell cash flow rentals.. there are many on this site that do just that.. And don't bat an eye lash at it.  some of us licensed guys get a little worked up but we get over it.

    yes please post. examples if you will of:

    Memphis

    Houston

    Dallas

    Atlanta

    Birmingham

    Charlotte

    philly

    Detroit

    and Cleveland

    those are kind of the top TK markets I see on BP  Oh and Kansas city

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    11y

    @Bogdan Cirlig 

      OH and forgot  Indy  .... Indy gets a lot of play as well.

  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    11y
    Originally posted by @Bogdan Cirlig:
    Originally posted by @Jerry Poon:
    Originally posted by @Bogdan Cirlig:

     Where did you get these graphs?

     Follow the link in my sig. Can't post directly as per forum rules.

    You have to be careful of over relying on this kind of data. Most of these data providers report at the census tract level which for many markets is far to broad. In markets that are neighborhood to neighborhood, this won't be very meaningful.

  • Real Estate Investor · Los Gatos, CA · Member since 2014 · 226 posts · 89 votes
    11y
    Originally posted by @Mike D'Arrigo:

    You have to be careful of over relying on this kind of data. Most of these data providers report at the census tract level which for many markets is far to broad. In markets that are neighborhood to neighborhood, this won't be very meaningful.

     Umm.. bit confused. Census tract is the smallest geo unit you can get, (there are census blocks, smaller, but meaningless for statistical purposes in this context) smaller than a zip or neighborhood. Also Census tract is very uniform as it's designed to be that way and it includes a certain number of households (less than 4,000 people so generally around 2,000 households) hence the geo area of a Tract can vary in sparse vs densely populated areas of a city. You want such charts to be at Tract level (which is the point, we do provide those charts at census tract level). 

    http://en.wikipedia.org/wiki/Census_tract

  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    11y

    @Bogdan Cirlig 

    You're right, census tract is the smallest geo unit but in some markets, like Indianapolis, they are still too large. I gave up looking at census tract data in Indy long ago because it doesn't account for differences at a neighborhood level. There's no substitute for knowing an area at the ground level and you don't get that from statistical data.

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