Investing in C/D Neighborhoods. Good or Bad Idea?
Raleigh, NC · Member since 2019 · 28 posts · 6 votes
Hello. I am looking to purchase my first rental property this year. I'm currently house hacking where I live now. I am considering investing in a market that I'm vaguely familiar with. I ran the numbers and looks to be a good deal even with having 10% in Cap-Ex and Repairs per year but the downside is the school rating is only 3/10 and higher crime rate where this location is.
Based on the numbers it would be above a 20% ROI which is fairly good but not sure if the schools and crime could be a major part of the factor when investing or end up making a poor decision just being the numbers look good. Any tips?
Hey @Jason Cook! I would suggest using a different metric than cap rate when you are talking about single-family properties in C-D neighborhoods. Cap rates in low-income areas are inherently high since a cap rate is just a ratio of how much money you bring in (usually high since C-D a competitive rental market with fewer homeowners) to property value (obviously C-D neighborhoods have lower values). Despite what most people think, cap rates are less of a function of revenue/return are but instead an assessment of risk. Higher value neighborhoods usually have lower cap rates since the values are so high, but a low cap rate does not make it a bad investment since those areas appreciate more aggressively.
In your situation, high crime rates and bad school districts usually mean amazing for cash flow, and if executed with the right systems. Picking the right tenant is HUGE for this business model. There are good people in the hood just as there are in the A-class neighborhoods. Unless you are picking up a ton in a short amount of time issue, one issue with going to low-income areas that are not clear on the path to progress is slower wealth building since there is not much more you can borrow on the house over the years.
@Jason Cook it all depends on your market. Usually in areas like this, you'll have higher vacancy and higher capex/repair costs. Almost any property can be a deal - you just have to know what type of deal you're getting and what comes with it. If you're investment criteria includes C/D neighborhoods and these types of properties then this could work for you. You'll really need to focus on having a rockstar PM in rougher areas though. It can lead to some big problems if you have a lazy and bad PM.
The question I always lead with is "what is your end goal?"...
While the numbers look good, if you goal involved PASSIVE income, then dealing with tenant issues in these types of neighborhoods may not be worth it. Are 100% of tenants in C/D problematic? No. But they are C/D "rated" for a reason and that traditionally comes with its own set of issues in general. When you look at who can and can't pay bills as a result of economic changes will this are be affected, or is it currently heavily affected?
Key here is having a GREAT team and a GREAT PM that is experienced in the area. But again, think about your end goal and work backwards to make sure these properties fit into your plan.
Karl
We love them BUT we always pass them off CFD or hold the note to investors we know who are very familiar with the area & know how to deal with tenants & maintain them on their dime. We do nothing to them & unload them 'as is'. It's definitely an unusual niche but very profitable.
Just had one pay us off after 10 years. We picked it up in foreclosure for $13,500 no kitchens or bathrooms. Sold it CFD 'as is' $35k, 13%, 10 years. He was a biker dude & never missed a payment. He still has the same tenant from the day we signed the deal.
We had another that will be paid off in August this year. We got it for $20k & had it rented to a woman who direct deposited every month, so after 12 years I offered it to her for $1 but she refused.
One of our C/D type investor/contractor guys wanted it for the double garage so we sold it & held the note, $35k @ 12%, 10 years & she is still there direct depositing (now $675/m plus utilities & water). It's an interesting demographic but it has been an absolute gold mine for us.
@Jason Cook
It takes a special person to manage in these areas . Don’t just assume you’ll be passive investing lol you get a high turnover rate high rate of eviction and they bang the building up pretty good when they leave .
Also don’t assume you’ll just find a PM and put it on auto pilot , in very bad areas no one will manage the building it’s not worth it to them . We have entire city blocks / steers that literally you can’t find a property manager to agree to do it . If you can be as savage as the tenants you will make money . If you grew up middle class have a big heart and drive a Range Rover then don’t bother
@Jason Cook Some tips, consider looking for federal and state programs that pay for 85-100% of the rent. Many programs available outside of say section 8. Negotiate for two months of security deposit because they will be rough on the unit. The advantages can be above average rents (some cases 30-40% more) and a steady flow of tenants to offset vacancy turn times.
It’s possible to make some fantastic returns, just have your processes dialed in.
The best PM you can get is yourself. With everything online, you can collect payments via Cozy, setup a tenant support ticketing and telephone support system for 10 bucks a month and use Yelp, Thumbtack, Home Advisor to find pros to fix things that break. If you want added security and eyes on the building, you can setup Ring cams all around the property and have eyes in the sky for 100 bucks a year.
Seriously, the best way to learn the ropes is to go in with both feet. I've invested in places over 150 miles away. Initially, I had a PM, they've been horrible. Guess what, they will not care about your property as much as you do. Generally, we're now in CT/MA and Westchester, but we still have a couple of buildings in Philly and Troy. Trust when I say, I've gone through many of them, three in Connecticut, four in upstate NY.
I'd prob. recommend staying away from D class areas. Yea, the ROI is high, but the repairs are going to kill you financially. Plus, the tenants you bring in are going to be less than stellar. Stick with B-C areas, preferably a fixer-upper and go from there. That's where I started.
Hey @Jason Cook! I would suggest using a different metric than cap rate when you are talking about single-family properties in C-D neighborhoods. Cap rates in low-income areas are inherently high since a cap rate is just a ratio of how much money you bring in (usually high since C-D a competitive rental market with fewer homeowners) to property value (obviously C-D neighborhoods have lower values). Despite what most people think, cap rates are less of a function of revenue/return are but instead an assessment of risk. Higher value neighborhoods usually have lower cap rates since the values are so high, but a low cap rate does not make it a bad investment since those areas appreciate more aggressively.
In your situation, high crime rates and bad school districts usually mean amazing for cash flow, and if executed with the right systems. Picking the right tenant is HUGE for this business model. There are good people in the hood just as there are in the A-class neighborhoods. Unless you are picking up a ton in a short amount of time issue, one issue with going to low-income areas that are not clear on the path to progress is slower wealth building since there is not much more you can borrow on the house over the years.
@Jason Cook That tends to happen, areas with worse schooling and worse crime have higher cash flow simply because the appreciation in those areas have not happened as high as they did the in B and A areas.
I think its important to realize that here, you will likely want a better property manager (so maybe this means to budget a higher percentage for that cause likely they cost more), budget more for vacancy if you consistently get bad tenants, and budget more for repairs and maybe those tenants will not take of the property as much.
I personally invest in C areas because I think its the sweet spot between D areas which have too many problems and B areas which tend to have higher home prices (Which eat into my cash flow)
I second @Antonio Cucciniello, I buy in C areas mostly because the tenants are decent and the cash flow is still good.
Another part that I don't think gets talked about enough in C/D areas is the necessity to scale QUICKLY here. I bought 40 properties in 4 years, and that helped me tremendously when one went south. I could spread the expenses of a large repair/turnover across all of my units and not get hurt. If I only had 1-2, I would have found myself coming out of pocket for those repairs which could have hurt pretty badly. You are probably not as likely to have those expenses in a A/B area.
Not necessarily arguing either way, it's just important to understand the differences and make the decision. I am starting to slow down in the C/D areas and move to the B/C areas to make the return a little more passive as everyone above has said.
Hey @Jason Cook, the first steps I would recommend as a new investor is to get a handle on analyzing the income, expenses and ROI of these properties in Bridgeport.
You can use the Bigger Pockets calculators to start. Use Zillow and rentometer.com to get data and analyze a few from your home to see what type if returns there are.
If these meet your investment criteria then start looking in person.
Let me know if you have any questions.