Why would I want to buy rat holes?

77 Replies

I always see cheap houses for sale in my market and they are complete rat holes and the realtor always says “great investment property” well my question is do the best investments always come from rehab? Wouldn’t it be better to buy fully rehabbed move in ready houses so that all of the rehab is paid for with OPM? I am a new investor with no rehab experience yet, but I would rather not have to fix up properties and instead leverage my debt for immediate cash flow. Is rehabbing ever the way to go for buy and hold real estate?(besides BRRRR)

Better returns can be had in the rat holes in good locations. But rat holes in rat hole locations can be the worse.

The problem with buying turnkey is getting them to cashflow. Someone else took the risk and fixed up that rat hole and expects to get close to market value.  If the numbers work then help yes buy the rehabbed property. They are much harder to find. They can be had if you look hard enough.

Hi Alec, I don't think there's a better or best way. Sounds like you would be better off going the turn key route. My portfolio are all buy and hold rehab "rat holes". In my opinion you can make exponentially more on rehabs than turn key, think of all the work being outsourced and everyone taking a silver. Two different strategies though, not one is right or wrong.

The reason to get houses that need are underperforming and / or in need of rehab is because you can buy them at substantial discount prices . Then once rehabbed they appreciate ( forced appreciation)and appraise much higher and the. you can pull the money back out of them through a cash out refi . In my Research over a long while looking at deals in the “ good” and “ bad” parts of town . The more I looked at the more I realized an interesting phenomenon occurs in many cities : for the most part rents are about the same and the rental market is very strong in the “ bad” side of town as it is in the “ good side . Also the properties sell for less than half compared to the “ good “ side of town . This sets up a nice situation for those not afraid to invest in c or d class neighborhoods . You may not get the appreciation but you will more than make up for it in cash flow

Thanks for the responses! Not saying I wouldn’t buy rat holes down the road, but if it cash flows and it appreciates why put all that extra cash into the property? Tell me more about the kinds of cash flow you get before and after a rehab and your CAP rates. I do see what you mean with cash flow being much greater in the C and D class neighborhoods something I definitely want in my portfolio if it’s a good deal.

I refuse to deal with rat hole houses in rat hole areas....you typically get rat hole tenants in those areas! And the “rat holes” in the good areas are nearly non existent in today’s market. Be patient...the deals will come again....

Rat hole houses attract rats. :) If it's not in a rat hole location, then that would be a win, but if surrounded by other rat hole homes, it seems the local rats would just want to move into the nicer home and return it back into its rat hole condition. 

I am not 100% on board with using equity to buy more investments in case, dare I say it, a 2008 happens again. It’s a great method for acquiring properties with minimal capital, but I prefer a 1038 for more doors (just my opinion).

@Alec McGinn , I agree with your sentiment. I too buy properties that a rehabbed and ready to rent (Someone else's flip). We don't have to choose between two polar opposite choices of beaten down "investor specials" and full turnkey. There is a lot of middle ground. I don't have time or skill for rehabbing homes. I am a long term buy and hold investor and concentrate my energy on keeping my properties fully occupied with market rents. 

@Alec McGinn I think the reason your confused is because you haven’t crunched the numbers carefully enough

There are two big reasons properties in need of repair are usually a better deal than similar properties of the same type and class that don’t need repairs . First, they are usually non-financeable though conventional means, so the demand is lower and thus the price is significantly lower as well. Secondly people calculate risk at a premium. So if a dwelling cost on average 20k to bring to average condition the market will discount that property much higher then 20k allowing the frugal and knowledge rehabber immediate equity.

It's about the bottom line and your goals.  Dealing with a property that is in bad condition is usually going to have the chance at picking it up at a better discount.  If you buy a fully renovated property , chances are the investor that renovated already took a piece of the pie for himself.  It doesn't mean it can't work, it just means that the deepest of deals are usually properties that most people would never want to step foot in.  

Originally posted by @Alec McGinn :
I always see cheap houses for sale in my market and they are complete rat holes and the realtor always says “great investment property” well my question is do the best investments always come from rehab? Wouldn’t it be better to buy fully rehabbed move in ready houses so that all of the rehab is paid for with OPM? I am a new investor with no rehab experience yet, but I would rather not have to fix up properties and instead leverage my debt for immediate cash flow. Is rehabbing ever the way to go for buy and hold real estate?(besides BRRRR)

You are on to something here. Too many investors get stuck on cash flow & forget that the most important reason to invest in rental real estate is the ability to finance.

You get 10 30yr mortgages. You'd have to be a fool not to use them. The 30yr mortgage is by far the best financial product out there. It is what sets real estate investing apart from all other investment vehicles. 

Plenty of time to pay cash for "rat holes" AFTER you have used all 10 of your 30yr mortgages.

Originally posted by @Alec McGinn :

I am not 100% on board with using equity to buy more investments in case, dare I say it, a 2008 happens again. It’s a great method for acquiring properties with minimal capital, but I prefer a 1038 for more doors (just my opinion).

One point about "rat holes" is that they've already succumbed to their own financial crisis! ie. A future downturn in the economy shouldn't affect their value any worse (because, your offer should already be ridiculously below the market value of the turnkey house next door). And so long as you rehab them to rent-ready standard (ie. efficient use of funds), guess what also happens during downturns? Answer: Even more people would be needing places to rent! 

Time to rethink your risk tolerance? [Have a good re-read of James' post above]. Cheers...

@Alec McGinn ,

It's all about your goals.   Personally, I'd NEVER buy a turnkey,  because our business model is focused on finding those "ratholes"  and making them gorgeous homes.    As  @Brent Coombs pointed out, by buying at their lowest point... you will NEVER lose money, you're getting in at the absolute lowest point possible... also.. for those worried about a recession, those in nicer low income homes actually don't  worry, just means more people will be seeking cheaper rent.    

It's all about what you want, and your business plan.   Buying in C/D areas isn't for everyone, and for those like myself who focus on the rehabs---I'm happy to be there with less competition! :)  

Simple, because lot of buyers don’t want to buy a rat hole too, so they are the cheapest.

I do understand how value can be added with forced equity rehabs, and you can acquire the property for low costs, but then to rehab the property you have to use capital to get the place up to renting standard. So for the time being and since I am young, wouldn’t it be better to acquire cash flowing properties that are move in ready that already have rehabbing costs fixed into the mortgage? Then I can keep my capital to buy more properties? The rat holes in my market are a lot more expensive than the ones in Cleveland lol

Thank you for your responses!

That capital used for rehab will be recouped in the refinance part. I don't think you are fully comprehending the BRRR method, yes it's more capital upfront but your are pulling it back out. For example my last purchase was 72k, after rehab I was in 100k, appraised for 170k. Pull out 120k, so I have my capital back plus some and cash flow a couple hundred a month. If I bought it turn key for 170k I would be out 34k+ with no chance for recoup in the near future. You mentioned you didn't want to use equity as purchasing power though so maybe it's not a good method for you, nothing wrong with that.
Originally posted by @Alex Presnell :
That capital used for rehab will be recouped in the refinance part. I don't think you are fully comprehending the BRRR method, yes it's more capital upfront but your are pulling it back out. For example my last purchase was 72k, after rehab I was in 100k, appraised for 170k. Pull out 120k, so I have my capital back plus some and cash flow a couple hundred a month. If I bought it turn key for 170k I would be out 34k+ with no chance for recoup in the near future. You mentioned you didn't want to use equity as purchasing power though so maybe it's not a good method for you, nothing wrong with that.

This is a best case scenario. Lots of factors at play that would prevent an investor, especially a new one like the O.P. from accomplishing this task.

  • Market is hot right now. There aren't tons of REO's just chillin on the MLS like back in 2013.
  • Competition is fierce. Other more established business operators with proven systems likely have the infrastructure to get to the scarce amount of distressed inventory before your average 1st time investor ever would. Beyond getting to it quicker they also have the ability to outbid the newbie as they can renovate it cheaper & resell it with lower selling costs.
  • Risk. Dude is brand new. There is a ton of risk involved buying a distressed asset. Does the average newbie investor really know how to properly calculate the ARV? Are they really able to get an actual timeline & budget for a large repair? What about all the unknowns that pop up and throw a curve ball at the most sophisticated & experienced investors. The additional risk that a property like this brings to an investor should never be overlooked.

There is nothing wrong with a new investor buying a simple home in good condition with good financing terms.

@Alec McGinn I struggle with this decision of buying a property that needs work, versus buying a property that is ready to go. Early in my investing career I would purchase the ugly ones that were selling cheap because the owner delayed updates. I found that after replacing everything, you can end up putting in as much money as just buying something with updates. I stopped buying the 100 year old houses and I am post 1980 now on everything. That means no lead, no cast iron pipes, no asbestos, no rubble foundations, no undersized fuse panels. Basically I eliminate all the issues of the old properties. Better properties attract better tenants.

I got a property under contract yesterday that was built in 1996. It has a new roof, new windows, new HVAC, walk in closets, open floor plan. I paid a premium over the 1980's houses, but my rent will be higher and my CAPEX will be very low. After closing, it will be move in ready. No months spent on rehab, no pushing people to get work done. No writing rehab checks or refinancing. I will just lock in a 30 year loan and cash flow day one.

I am really not a big fan of the BRRRR strategy at this point in my investing career. I know everyone hears BRRRR so much on the podcasts that they come to believe that is the only path to success. I just don't want to deal with the hassle for marginal gain. For me 6 months vacancy is $8000 in lost rents. An hour of my time is worth $150 or more, so do I want to spend my days chasing people to get work done - or worse yet do I want to do the work myself? I did when I was young, so maybe the lesson here is that different strategies come with different phases of your investing career. I am just realizing that time is worth more than money.

People say buy cheap and rehab, I say buy it rent ready and cash flow day one.

People say more doors is better, I say more doors is more tenants, more time and more hassle. I want more dollars per door, not more doors.

People say buy in a C or D area to maximize cash flow, I say it is not worth the PITA factor. Marginal gain over time unless you let the property deteriorate to nothing. I take care of my stuff, so I can't let things break and not fix them - not in my character.

Lots of paths to success. I may be contrarian to what others are doing, but sometimes taking the opposite approach is a good thing.

I am curious about Rochester.  Does Rochester have any special characteristics which would make investing in ratholes better or worse?  I imagine it is quite difference from Chicago or San Diego or Denver or Lansing Michigan.  

My personal focus is not to invest in ratholes, although it worked for me by buying low-cost houses in Chicago which appreciated (Wicker Park) in which the value was in the land.  I bought at $30,000 hoping the land value would go up.

@Laurence Smucker It is interesting that you say that because I was just thinking through an opportunity that I have here. There is a property on the market that personally I would never live in, but obviously, someone does. Maybe I need a reality check that there are people that this property would actually be a step up. I don't know how I feel about buying properties that are in such condition though. Of course, I would want everything in working order, but I tend to want to rehab everything to like-new condition. I think I'm going to have to get over that if I'm going to make money. Or is there a place for people like me in this business?