How to evaluate a neighborhood for SFR

Question

How do you evaluate a neighborhood for purchasing a property for rental income?

Let's say your looking at rehabbing a home to turn into a rental.  The neighborhood is very mixed: long term owner occupied homes, a few abandoned/dilapidated homes, and several homes that have been rehabbed for rentals.  I have a good handle on the cash flow because of rental income projections, but I don't have many good comps to determine ARV, because the recent sales are pre-rehab.

Marcus Auerbach · Answer

@Chris Eidson it takes a good deal of local experience to answer this question, but I will try to from a Milwaukee perspective.

When I evaluate a street I pay attention to the following:

- curb appeal of the homes; does the street feel "homy", would someone want to live here?

- condition of the homes, roofs, windows, chimneys, driveways, garages - are people keeping up?

- condition of the cars parked; any jacked up cars with no tires?

- seasonal decoration; absence of xmas decoration etc is a bad sign, people have lost pride

- smells and sounds

- people outside, especially on a nice weekend, who is outside, what are they doing?

If you don't have any comps that have been rehabbed that's a bad sign. It means that people who have a lot more experience than you do not BRRRR invest or flip in the area. Even tough prices might be low and cash flow is great, you need the upside, both for buy and hold and to flip. Without the upside you won't be able to fund capex in any other way than cash flow. And capex is usually greater than cash flow in the long run. It shows usually very clearly when you calculate IRR instead of just static ROI. It's a mistake that we all have made at some point when we fell in love with what looked like an opportunity (a much bigger/better house for a lower price) and then over-rehabed it for the noghborhood. You have to stay at or below the top standard for the neighborhood; don't try to be the one who raises the ceiling for the entire neighborhood all by himself.

Rebecca Knox · Answer

Right, I don't use those comps that were done by Habitat as those are newer builds....and the surrounding streets don't really have any rehabs going on....yet.

Dave Carpenter · Answer

I know this is offline a little, but curious @Rebecca Knox what about the Habitat areas are difficult? Is it that you have a bunch of new houses but without traditional sale prices, so using as comps is hard?

Rebecca Knox · Answer

I understand. I find it difficult in the Sherman Park area and also areas where Habitat for Humanity has come in. I like that area around 20th & Walnut...crazy driving in that area because you see brand new houses on one street and roadside memorials on the next :(

Chris Eidson · Answer

@Rebecca Knox

Thanks.  I am going to hold it for rental, but I still like to know what my appreciation opportunities are.  This was more of a general question as I look for future deals as well.  It seems to be much harder to project ARV in a speculative neighborhood.  Obviously, I could go into a neighborhood that has already fully turned, but typically opportunity for returns and cash flow diminish.  I'm trying to get ahead of the curve.  That's the main reason for my question.

Rebecca Knox · Answer

In the city, going out further than .25-.35 could be an entirely different neighborhood. Did you trying going back further on the sales dates?

You mentioned that there are several homes that have been rehabbed for rentals and you are looking at rehabbing the home to turn it in to a rental----can't you use those sales?

I had a property in Cold Spring Park 53208, that the appraiser could not find comps in the neighborhood--he used comps from 53204--a neighborhood on the south side and explained on the report that he used comps from that neighborhood because it was similar demographics.

You could also get an independent appraisal. May be a good idea especially if you are paying cash because you can use the appraisal to argue later during the re-fi if you have to.  You can tell the appraiser what you plan on doing to the property and they can forecast what it will be worth. Debbie Duessler from Whitehouse Appraisals charges $275 for SFRs, a little more for duplexes.

Chris Eidson · Answer

@Chris Connolly

That's my dilemma.  The current street and adjacent streets are about 65% rental as best I can tell and the owner occupied homes show a decent level of pride of ownership, but there are no rehabbed comps on the street that have hit the market yet.  There are a couple of tear down/new constructions on the market now for the high 300's @ 150/sf.  They are about 2 miles away, but same school district.  There is one under contract that was purchased for 20k and listed at 119,900, but it is on the other side of the freeway about 1 mile as the crow flies. It is the exact same price/sf I anticipate after rehab, but it is larger.  I should have 66k in it when I'm finished.

Chris Eidson · Answer

@Chris Connolly

That's a really tricky question.  This is on the edge of a up and coming market that has seen pretty strong appreciation and revitalization.  There is new construction in the upper 300s within 1.5 miles. (tear down and rebuild).  No difference in school districts.  I think I will have about 66k all in on this rehab.  As best I can tell, it's about 65% rentals on the street and there is some pride of ownership in the owner occupied homes, but there are a couple of badly distressed properties as well.  One rehab that the seller paid 20k is now under contract with a listing price of 119,900, but it is almost 800 sf larger.  Sq foot price is right in line with this prop at 66k.  I feel like there is room for appreciation, but I may be a little early.  I don't see this as any possibility of a flip, but some appreciation coming in a year or two.

Chris C. · Answer

how close to market value is the asking price?

Chris Eidson · Answer

@Marcus Auerbach @Aaron Stuiber

Thanks.  There are recent sales to investors and there are rehab projects going on right now.  Nothing on the street has hit the market.  Just considering this neighborhood because I'm trying to get a jump on the area.  I am not planning on flipping, but always want to have an exit strategy.

How to evaluate a neighborhood for SFR

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