If you are buying lower cost SFH's what is your exit?

Question

Many new investors gravitate towards the lower cost SFH's because they are easy to finance, abundant in many markets and are the easiest pathway to completing the BRRRR which most new investors view as the ultimate real estate success story. Unfortunately very few who seek out these assets take the time to consider their exit and fail to realize they are the most costly assets to exit, let me explain why:

Here's how that disposition process to an owner occupant looks:

-You will incur turn over expenses associated with vacating the tenant in preparation of the sale

-The natural buyer in this price point is the FHA buyer who will normally seek a 5-6% seller assist

-Passing a Section 8 inspection/preparing a home for a low income tenant is very different than the expectations of a home owner, particularly the FHA buyer who cannot afford to take on any deferred maintenance. Therefore expect a 15 page home inspection report filled with corrective measures you must satisfy otherwise the buyer walks.

All in between turning over the home, ordinary transactional costs ( broker fees, transfer tax, loan payoff fees etc.) seller assist, repair addendum repairs its very possible for your exit fees to approach 13-15% of the properties sale price.

Next the investor: Investors will not pay retail for these assets because there are no barriers of entry and they can complete the same process you completed given the abundance of distressed assets available in these markets. Alternatively they can purchase a portfolio of occupied homes at a discounted price because the seller of the portfolio in most instances first tried their hand at selling the homes individually to the owner occupant and after experiencing 13-15% in disposition fees and expenses realized its not worth the effort and better to package the assets and sell discounted to another investor.

Keep in mind, most of these SFH's are in stagnant markets meaning limited appreciation and if you ever took the time to look at an amortization schedule there's no meaningful principal paydown for many years. Some may say they can pay down the principal more aggressively with cash flow, but reserves are necessary in this asset class because Capex disproportionally impacts these lower priced SFH's and ordinary repairs can easily wipe out months of cash flow.

If you chose to go this route, the home must have meaningful appreciation otherwise you will be running in place and the only people to make out are the transaction fee earners (Sales Agents, PM's, Lenders) and perhaps FHA buyers who get a home with a 3.5% down payment with the benefit of a seller assist and a 15 page corrective report completely satisfied. Unfortunately satisfying a BRRRR & marveling at the spreadsheet cash flow and equity are what lead to purchases in stagnant markets and very few who invest in these assets pay any attention to the fundamentals that lead to meaningful appreciation where a gain can actually be realized.

Stuart Udis · Answer

@Basit Siddiqi Yes, there are selling costs associated with selling inexpensive and expensive homes. However, you are far more likely to pay 5-6% seller assist when selling the lower cost SFH. Repair addendums are often far more daunting because the buyer can't afford to take on any deferred maintenance. Meanwhile many of these repairs are fixed cost whether its a $100K house in the C/D neighborhood of a respective market compared to the $500K in the same market. In all, the transactional/exit fees are disproportionately higher when selling the inexpensive SFH homes. It is very rare to pay between 13-15% when exiting the SFH in the more expensive markets but its a very real possibility when selling the less expensive homes.

Your data is also city wide and if you were to focus in on the lowest tier neighborhoods in these markets they tend to be the most stagnant and this is where many buyers who invest in the lower cost SFH home strategy focus their investments.

Corby Goade · Answer

I agree with OP 200%. It seems like it's less risky because it's cheap.

But why is it so cheap?

Supply and demand- if there were demand-, it wouldn't be so cheap. If there weren't such a big supply, it wouldn't be so cheap.

Same on the rental side- demand- will be low, so you have to take on less than desirable tenants, which are costly and time consuming.

A couple years later, repairs, vacancy and turnover costs and you've actually lost money every month and you've decided to sell and buy in a more desirable area, but the property hasn't appreaciated, you have to fix it up to sell and incur transactional costs and you lose even more money.

Contrary to popular belief, this is actually an advanced strategy for people with lots of experience and resources, it's a really tough place to start. Most people who start here cash out, lose money and are burnt on rentals and give up. They think LTR doesn't work, but it's really just the strategy and location.

Basit Siddiqi · Answer

In my opinion, you can make as much money buying cheap houses as you can buying expensive homes.

Affordability is an issue for a lot of Americans so I will argue cheaper cities performed better over the past 10 years than more expensive markets / houses.

San Francisco, CA, Seattle, WA and New York, NY are considered expensive markets.
If I look at Zillow's price estimate for homes comparing 2016 and 2024

San Francisco - Average Price of home was $1,145,000 and now its 1,262,000(Increase of 10%)
Seattle - Average Price of home was $561,000 and now its $848,000(51%)
New York - Average price was $561,000 and now its $766,000(37%)

Memphis, TN, Indianapolis, IN and Clevlenad, OH are considered cheaper markets.
Zillow is showing more appreciation in these markets over the same time period
Memphis - Average price was $73,000 and now its $149,000(104%)
Indianapolis - Average price was $107,000 and now its $225,000(110%)
Cleveland - Average price was $54,000 and now its $109,000(101%)

Population increases and job growth are two indicators that result in appreciation.
Two of the cheaper markets listed above(Memphis and Cleveland) are not increasing in population. However, there is a big push for investors to chase 'yield'(Cashflow) which is likely pushing these markets even higher.

I purchased about 30 homes in Jacksonville from 2020 to 2022 below the cost of $72,000. I only sold a few amount of properties but the values of the homes have increased.

The government is making less affordable homes(Impacts supply)

A lot of the points you suggested such as selling costs and having to rehab the property before sale apply to both cheap homes and expensive homes

Basit Siddiqi · Answer

Is there a report that says lower priced homes are more likely to have a seller assistance?

Furhermore, is it possible that the seller assistance already facors in the FMV of the home?
If a seller listed a home for $100,000 but was willng to sell for $94,000 as that was likely the FMV, it would be the same to him if he accepted $100,000 with a 6% seller credit or $94,000.

I looked at the zip codes of lower priced homes in Memphis, Cleveland and Indianapolis and they appeared to perform better

Memphis
38105 - Prices were $35,700 in 2016 and now $116,000(220%)
38106 - Prices were $21,600 in 2016 and now $60,900(180%)

Cleveland
44108 - Prices were $34,000 in 2016 and now $59,800(74%)
44104 - Prices were $36,300 in 2016 and now $60,400(66%)

Indianapolis
46201 - Prices were $42,900 in 2016 and now $149,000(247%)
46222 - Prices were $39,000 in 2016 and now $127,000(225%)

I should mention that I don't invest in Memphis, Cleveland or Indianapolis. I am just looking at numbers provided by Zillow.

I agree that the cost for most items such as a Roof, HVAC, Piping will be similar between a cheap home and an expensive home. The expensive home may use better brands which might be slightly more but immaterial in this situataion.

Where did you find this information that cheaper homes are likely to give more of a repair credit?
Can't the seller disagree to the repair concession?
If you mention that the buyer can't afford much, he/she may not be able to afford paying for several home inspections and not closing.

Stetson Oates · Answer

There is a lot of speculation in this thread. What’s lower cost? Why do they automatically get thrown into section 8? Why are the buyers automatically a FHA buyer seeking 5-6% seller assist? IMO there is a wide spectrum on lower cost SFH.

V.G Jason · Answer

Whose saying buy expensive homes? We're saying don't try to find the lowest hanging fruit.

Eric Gerakos · Answer

This should be required reading for new investors, drooling over the great cashflow they will make buying crappy houses in crappy neighborhoods that attract crappy tenants. They don't associate cheap with undesirable.

Stuart Udis · Answer

The natural buyer of the entry level SF homes have limited cash and therefore the biggest obstacle they face is funds to close. The workaround is using seller assist. Sure, any buyer can use this as a tool, but its more essential for those with limited cash. Using your $100K example, the 6% seller assist is far more valuable to this buyer than merely reducing the purchase price by $6K because the 6% seller assist is a $6,000 reduction in funds required to close whereas reducing the purchase price by $6K equates to less than a $200 savings (2.5% down payment + some incidentals). I also don't believe it will be easy to gross up the sale price by the 6% and offer it as a concession although I understand your logic behind that strategy. FHA appraisals are very strict.

Along the same lines, the buyer who can barely qualify for the entry level SFH is acutely aware of their cash shortage and therefore are going to be less accepting of household features near the end of their useful life, even if still functional and have a stronger desire for anything that is listed as a deficiency on the inspection report to be corrected. This is why the repair addendums tend to be more of a burden.

This is the reality of selling the entry level SFH's. Perhaps you get lucky if you are selling a small sample size but if you sell volume you will find this to be the reality more times than not. I happened to be someone who experienced this first hand selling close to 30 towards the beginning of my real estate investing career nd know quite a few peers who experienced the same sale process.

There is no way the data you pulled accounts for concessions. They are rarely reported accurately by realtors on the MLS when transactions close to begin with and I don't believe anything other than the contract sale prices are utilized although an official study on this would be very interesting albeit a painstaking process to undertake.

Jay Hinrichs · Answer

The mindset of cash flow is everything and appreciation is just luck or gambling or whatever these folks say is one of the worst mindsets I see on BP.

As you note exiting any RE that does not have some appreciation of a significant amount over say a 5 to 10 year hold generally speaking is going to lead to a loss at sale. ANY RE.

Or at least a big bite out of the positive cash flow the asset made over those same years.

Especially if you cant 1031 and you have to pay recapture.

Even with new construction this has to be taken into account..

Or if your going to go into these areas its basically for life and that is OK but its generally not reality. It can be reality for a local who does this as a family affair I have seen that.

Investors just need to be realistic with their time lines and such.

Basit Siddiqi · Answer

I understand you experienced several items when selling your cheap homes. However, you are just one data point. It would be ideal to get some sort of large study done on this.

Furthermore, if you sold in a buyer's market, your thought may be skewed.
If your portfolio was in a market that was declining in value.

I am not saying that the above situations applied to you but it would be good to get a large study on this.

Furthermore, if we are talking about more expensive homes being a better investment? By how much?

Do expensive homes result in a 20% annual return and cheap homes only 5%?

If you are buying lower cost SFH's what is your exit?

If you are buying lower cost SFH's what is your exit?

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