?Building a Junker Portfolio

?Building a Junker Portfolio

Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes

In the last few months, I have met a few retiring landlords who were looking to unload their properties. When I looked at the properties, I was really surprised at just how junky they were. They were a bunch of 2/1s and 3/1s woodframes in m’eh areas. (In my area, investors prefer brick and anything less than a 2 bath is functionally obsolete.) They did not have decent ARVs or decent comps, so even financing or refinancing would be tough. Basically, they appeared to have been picked up some time ago because they were "cheap" and now, many years later, they are still "cheap". (Hilariously, with the passage of time, these landlords had come to delude themselves that these were quality properties.)

I think @Jeff Brown harps on this, but it really got me thinking a lot about the importance of buying quality homes in quality areas for your long term portfolio. (Or at least properties that everyone else wants).

In my area, the highest quality rentals are 3 or 4 bedrooms with at least 2 bedrooms and a 2 car garage (brick, not wood) with ARVs between $80,000 and $150,000. The rents are commensurate with the ARV, and they are super easy to rent because they rent between $900 and $1500, which is what the bulk of tenants seek. They are also a great price point for first time home buyers. They are also very easy to finance, even after you get 10 mortgages. They are also (unsurprisingly) the homes with the highest demand and most competition.

When you are building an SFR portfolio, I think it's easy to become frustrated and compromise on the criteria of properties you add to your portfolio. Having done this awhile now (and seen where a junker portfolio gets you), I think this is really short-sighted for most investors. (I use the term "most investors" to describe people who want to balance ease of management with cash flow.)

First, you will end up with a portfolio of properties that is illiquid. It will be harder to sell or refinance, which is huge. You don’t know where you’ll be in 5 or 10 years, and if you want to move to the “next step” of real estate investing, whatever that may mean to you personally, you’ve got to be able to get to the equity in the properties you own.

Second, your chances for appreciation are limited. (yes, I know we shouldn’t buy for appreciation, but it’s sure nice when it happens). Heck, even just keeping up with inflation is important, particularly when you start to get a large enough portfolio. Junker properties stagnate (or decrease) in value.

Third, your chances of having a more difficult portfolio to manage becomes greater. (Not saying this guaranteed, but in my area the functionally obsolete tend to be in less nice neighborhoods with lower income tenants.)

I’m sure there are other reasons, these are just ones off the top of my head. I think most investors would be better served by (1) putting in more time to seek out quality properties (e.g. marketing); or (2) just pay more for them. In the long run, they’re likely to be better served.

I should throw out a couple of qualifications. First, I’m not bashing people who invest in functionally obsolete, nonconforming properties or in rougher areas (or both). You can make a killing on the cash flow, no doubt, but the headaches and difficulties are not for everyone. Second, I’m not saying there is no place in your portfolio for what I would call junker properties but you have got to buy them super cheap and as part of a larger strategy. I once bought a functionally obsolete property 2/1 for my portfolio in an almost-rough area. I bought it super cheap and understood it would be for cash flow purposes only, that is, that it would be difficult to refinance or grab the equity. I bought it only because I had enough quality properties that it didn’t matter. I wouldn’t. Third, I’m speaking in generalities in this post. These are just principles and there are obviously exceptions. Fourth, I’m probably being a little harsh in my use of the term “junker” to generally describe functionally obsolete, non-liquid properties. That’s more just my knee jerk reaction to the properties I saw recently.

I’m quite certain there’s nothing really novel in this post, but it’s just something I’ve been thinking about lately. Kind of curious if other people feel the same way.

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Investor · Fort Wayne, IN · Member since 2009 · 391 posts · 257 votes
12y

Hi John,

I wanted to share my experience. I have built what you would classify as a junker portfolio and have done well. I have a large collection of 3/1's in C class neighborhoods with a mix of section 8 rentals in there as well.

I have found the key to my success is a competent property management team. I invested for cash flow and do not anticipate that I will have much appreciation. I am able to get portfolio loans on these properties although I have only done this once.

I realize that I am going against the grain on this thread but just wanted to share my results.

Chris

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  • Real Estate Consultant · Kansas City, MO · Member since 2013 · 388 posts · 200 votes
    12y

    I completely agree with you. However, many investors, including those fantastic geeks that run this forum (Brandon), like to buy using multipliers, such as the 2% rule. In order to hit these numbers, even in "cheap" markets like my own, Kansas City, it requires that you take C- grade properties.

    I mostly work with out of state investors, whom for the most part are willing to compromise for some appreciation in the long term with a smaller cap rate up front, typically a 1.5% rule. Bread and butter house is $60k with $900 rent. What that doesnt get you is a 3 bed two bath 2 car garage house in a B area.

    Yes, there is money to be made at all levels from A to D- properties. Its all about management and the level of involvement. I will not manage below a C property. Too much risk at the chance of upsetting the investor in the long run.

    C-, and D properties should be managed by the investor, locally and with much experience and risk awareness.

    A & B properties are good alternatives that ultimately, as Ive argued in a BP Blog Post before that long term ROI after factoring all expenses are less risk and ultimately a better reward, even at the lower up-front yield.

  • Investor · Dallas, TX · Member since 2013 · 619 posts · 128 votes
    12y

    Great post @John Chapman

    I get "jealous" each time I read about other BPers purchasing houses for $30K-$60K, renting for up to $900/month, cash flowing wads of cash and wish I could find one in my farm area in Dallas. But I sleep much better at night knowing my brick $120K 3/2/2 fits my profile and this is a marathon not a sprint. Slow and steady is boring but...

  • Real Estate Investor · StL, MO · Member since 2008 · 294 posts · 152 votes
    12y

    I have thought about the 'junker' status before. For one, I've seen lots of houses that would be great rentals but would be tough to ever sell for one reason or another-one of a handful of houses on a block of multi's, strange layouts, ugly exterior etc. Do you buy those and make good cash flow knowing you will never get an increase in price and will be hard to sell in the future? So far I have been passing on most of those.

    Second is, what are the values of these homes? I have been working with a local lender to get LOCs on my investment properties and I'm having the issue of what is the after repair value. Even if I buy a house missing water pipes and needing a new sewer line, the bank is only offering a value of what I purchased the property for as there are so many foreclosures in my market they contend that there is no ARV regardless of improvements. So I have been bumping up the quality & price of homes I have been looking at in order to play their game better. My goal is eventually to get about $150k of LOCs on investment properties to operate with. It will be much easier to reach that goal with $50k houses that can appraise for more instead of $25k properties with no ARV. The bonus is the fees are less on a relative basis.

    I'm still glad I have my 'junker' houses and I'm still looking for great deals with them but generally I am looking to trade up in quality right now in order to hit my LOC target faster. Once I hit my target, I will have to see what seems best at that point.

  • Investor · Milford, CT · Member since 2012 · 592 posts · 285 votes
    12y

    In the northeast, specifically in Connecticut we have the same issue here but mostly with MFH. A lot of landlords bought these houses for peanuts years ago and rarely put any effort to update them. Just collecting the cash over the years. But now these properties aren't producing the cash like they used to because they never updated them and many tenants now a days watch too much HGTV to consider them. They are trying to sell them for $100k+ a unit that is just laughable and toting their great cash flow potential. My response is usually if its so great then why you are selling them. :)

    Another issue is the non permitted or non conforming number of units. This is something a lot of newbies get stuck with if they don't do their due diligence. We have a number of 3 families where originally they were 2 family but the owner made the 3rd floor attic into a 1 bedroom or studio.

  • Omaha, NE · Member since 2014 · 4 posts · 1 vote
    12y

    First post.

    Last year I bought a junker with the thought of cash flow. I am now frustrated with it and considering selling it off. Everything about it is bad, location, layout and needs a fair bit of rehab yet. Wish I had found Bigger Pockets last year to avoid this house. There are a number of these in the Omaha market some are better than this one and could be viable. Hopefully I have learned my lesson on junkers.

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    12y

    @John Chapman

    Can't argue with that logic or the reality of the C class and lower rental.

    When people look at the rental bizz.. they do focus on the highest cash flow possible but do over look the pit falls and many until it is way too late.

    You take the Portland OR. market were I live.. Very few come here to buy our 4 to 6 cap rentals.. But the locals buy them and keep them. As PDX has the 2nd lowest occ rate in the country behind only Silicon valley. Rentals here even on the low end are not anything like what you get in C props in middles America.. they aren't great looking places but they still cost 100 k for an SFR junker and 250 for a duplex and 350 plus for a 4 plex. .and 4 to 6% cap rates.

    with NO foreclosure activity to speak of in these properties.. Because unlike the Mid west the houses rent , people actually pay, and they pay on time and stay.. Because there is a shortage big time for rental housing.. 10 years ago only 6% of all SFR's in this market were rentals. with the big chill on the economy that probably spiked to 10 or 12% compare that with the mid west were is 40 to 55% in most markets...

    And then you add out of state and out of area to the mix in the mid west and its darn tough on the C properties to make them. work and they are anything but passive you will be managing your managers all the time. and one day your tenant will somehow get your phone number and call about something not working int he house and get it fixed etc etc.

  • Investor · Lucas, TX · Member since 2010 · 620 posts · 352 votes
    12y

    @John Chapman So you were listening to me during those lunches after all? ;)

  • Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes
    12y

    You know, it's kind of funny @Robert Steele , because I was actually thinking, in part, of your portfolio when I wrote that post. I started up in your neck of the woods with my first two because it was such a high quality, got frustrated not being able to lock down deals, and started chasing deals all over the metroplex. (Thankfully, I only bought one property in Garland. :)) I settled in Tarrant, and I'm pretty happy with how things have turned out, but I've wondered lately if I would have been served staying in the North Dallas/Plano/Allen areas. It was so competitive and the numbers never made sense "at the time." I put "at the time" in quotes because I was reading one of Trump's book and he had a quote that was something like, "Buying quality will look expensive in the present and cheap in the future." (I probably butchered that but I thought the idea was really good.) I probably could not have bought as many homes if I stayed in Collin County, but they would unquestionably be of higher quality and have appreciated better.

    @Gautam Venkatesan , yeah, I know what you mean. I have done exactly one deal where purchase price, repairs, and closing costs were something like $55k, and the rent was $900. (It was also worth about $94k when I was done.) It was hands down the best deal I've ever done in the metroplex and is not something I've repeated.

  • Investor · Middletown, RI · Member since 2008 · 174 posts · 27 votes
    12y

    @John Chapman you make some great points about the pitfalls of investing in "junker" properties. I think the key is to do your due diligence on the area to understand if it's growing economically or not from an appreciation standpoint. I would personally stay away from anything below a C level property for cash flow purposes. The headaches of managing the tenants and the potential for non-appreciation are just to much for me. However, as you said if the price is right and the area is improving it may work out long term.

    @George Paiva you make a great point about the non-conforming use aspect. You can easily get stuck with a property that is no longer grandfathered from current zoning regulations if it has lost it's continuous use status(sat vacant for an extended period of time). I agree that there are plenty of MFH properties in Connecticut that are completely outdated (electrical, plumbing, etc.) and run down but the landlord still wants top dollar! I would check what the local zoning codes are first to be sure everything is in compliance.

  • Investor · Lucas, TX · Member since 2010 · 620 posts · 352 votes
    12y
    Originally posted by @John Chapman:
    I settled in Tarrant, and I'm pretty happy with how things have turned out, but I've wondered lately if I would have been served staying in the North Dallas/Plano/Allen areas. It was so competitive and the numbers never made sense "at the time."

    I'm not sure what time that was but I suffered from the same problem between 2003 and 2007. The only place nearby that the numbers worked was East Plano. I still have my one and only junker there. For how much longer I am not sure.

    I managed to get lucky and pick up 2 quality properties during that time period. Both were in somewhat rough shape and both were bought privately before they even hit the market.

    Most of my existing portfolio was acquired after 2008. During that time and since then I have sold off most junkers and ones that were under performing. I still have only about half of all the SFR properties I ever bought.

    With the housing recession it was easier to pick up quality cash flowing properties. My last one in December 2012 was move in ready, producing $500 cash flow with 25% down. It is actually going vacant this month. I put it in the MLS yesterday and got two applications without a showing. Man the rental market is smoking hot here, at least for quality properties.

  • SFR Investor · Member since 2011 · 198 posts · 61 votes
    12y

    I have a few of these I purchased during the recession and they were fixed up to be the nicest homes in the neighborhood. They have almost doubled in price since I purchased them, I have the same tenants in them since they were rebuilt (they are very nice for the rent so tenants don't want to leave) and since I picked them up cheap cash flow is good.

    I don't buy them now because the numbers don't work out for me but if I found one cheap enough I would.

  • Investor · Fort Wayne, IN · Member since 2009 · 391 posts · 257 votes
    12y

    Hi John,

    I wanted to share my experience. I have built what you would classify as a junker portfolio and have done well. I have a large collection of 3/1's in C class neighborhoods with a mix of section 8 rentals in there as well.

    I have found the key to my success is a competent property management team. I invested for cash flow and do not anticipate that I will have much appreciation. I am able to get portfolio loans on these properties although I have only done this once.

    I realize that I am going against the grain on this thread but just wanted to share my results.

    Chris

  • Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes
    12y

    Hi @Chris L. , thanks for sharing. It sounds like you know what you are doing and have done well. I hope my thread did not come across as suggesting it was impossible to make money buying cash flow properties with no appreciation.

    Also, I'm not sure if I would call your portfolio a "junker". From what I can tell of Fort Wayne and other parts of the midwest, 3/1's are fairly common and not viewed as negatively as in my area. I think the term "junker" is a fairly relative term, and I would classify a "junker" as a property that is not as highly desired by other investors or homeowners because it is functionally obsolete, in a bad area, or some combination. I tried to stay away from the term A, B, C, and D properties, because I'm not sure that really captures what I was trying say.

  • Sheffield, IL · Member since 2012 · 85 posts · 27 votes
    12y

    I'll chime in to say that out-of-state investors should stay out of C and below. B class can even be risky. Where will that B area be in ten years?!

    I have some C's in my local area, but all out-of-state are A's.

  • Investor · Milford, CT · Member since 2012 · 592 posts · 285 votes
    12y
    Originally posted by @Jim Lally:

    I agree that there are plenty of MFH properties in Connecticut that are completely outdated (electrical, plumbing, etc.) and run down but the landlord still wants top dollar! I would check what the local zoning codes are first to be sure everything is in compliance.

    I typically price in for those surprises which oddly enough surprises the sellers more than anything when I submit my initial offer. My offers/numbers are for cash flow so I get a lot of misses. I've been pricing in a high vacancy accordingly as well, up to 20% in some cases.

    Whats scaring me lately in Connecticut is the mass exodus of the middle class who I used to rent to. My vacancies have been getting some interesting characters in the last year.

  • Investor · Fort Wayne, IN · Member since 2009 · 391 posts · 257 votes
    12y

    Hi @John Chapman,

    I did not take your post as ridiculing other options. I just wanted to share my primary lesson learned that it is all about the property management company. I routinely buy great properties from burnt out owner/landlords.

    If I were managing them myself, I would not own any rentals.

    I am always open to ideas/opportunities that create better returns.

    Thanks for starting this thread. It is always beneficial to hear how investors are succeeding in their markets.

    Chris

  • Investor/Realtor · Hoover, AL · Member since 2010 · 1k+ posts · 459 votes
    12y

    This is always a great topic! I enjoy the dialogue. Comfort level and investing style varies among investors depending on objectives. I enjoy cash flow with my "bread and butter rentals" but as I continue to grow I plan to diversify. We all start somewhere and continue growing..Get started...

  • Investor · Southeast, MI · Member since 2012 · 2k+ posts · 1k+ votes
    12y

    I have several "junkers". (That's a funny term for them). I don't buy junkers anymore. They cashflow great, but the quality of tenants is usually low.

    I know a guy with 120 houses in a Class C- area. They are all free and clear and all 120 are junkers. Mostly two bedroom houses without basements or garages. Lots of them have asbestos siding. He's in his 80's and always working. Always in court. I feel bad for the guy. He has all the money in the world and not a clue what to do with it.

    Quantity is not quality.

  • Rental Property Investor · Jacksonville, FL · Member since 2013 · 43 posts · 20 votes
    12y

    I personally am somewhere in the middle. I started out with just junkers as that's what I could afford without mortgages. Now I'm trying to mostly move into nicer rental properties. I still do pick up the occasional cash flow cheap property just to keep it--knowing that it won't go up much in value and that I will only be able to sell it to another investor. I just bought a C+ 3/1 last week for $12k with a sec 8 tenant paying $750/mth. 1.75yr break even. Couldn't pass it.

  • Investor · West Bloomfield, MI · Member since 2009 · 358 posts · 306 votes
    12y

    I question the assumption that nice houses in owner-occupied neighborhoods will appreciate and junkers won't. Historically, owner-occupied houses have appreciated at around the rate of inflation. Of course, some areas have boomed and some have busted and some have done both, multiple times, but in the long run appreciation roughly equals inflation.

    Junker houses aren't valued as owner-occupied homes, like nice homes are. Rather, they're valued based on their cash flow, like commercial and multi-family real estate is. An appraiser would calculate their value based on what they call the "income method".

    Rents historically have also increased at roughly the rate of inflation. All things equal, assuming rents and expenses all go up at the same rate (inflation, roughly) then cash flow will also go up at around the rate of inflation. Since an increase in cash flow translates into an increase in value when valuing real estate via the income method, even junker rentals will increase in value at around the rate of inflation, like nicer single family homes do.

    Now, I'll bet some are thinking about neighborhoods where junker prices have either stayed flat or gone down over time. Of course, that can happen. Values can also stay flat or go down in B or A neighborhoods. I've seen values in nice neighborhoods stagnate as the neighborhood ages and homes get built on the fringe, or as jobs and population migrate away. I've also seen bad, junker-home areas get trendy and appreciate to the point that C and B class tenants can't afford the neighborhood anymore and junker homes get rehabbed, added on to, and knocked down for new construction, with the junker home investor reaping the rewards.

    Bottom line, I don't think appreciation is a valid point of differentiation between nice and junker rental homes.

  • Investor · Lucas, TX · Member since 2010 · 620 posts · 352 votes
    12y
    Originally posted by @Tom A.:

    Junker houses aren't valued as owner-occupied homes, like nice homes are. Rather, they're valued based on their cash flow, like commercial and multi-family real estate is. An appraiser would calculate their value based on what they call the "income method".

    Err.. are you sure about this? I don't know of any lender on a 1-4 residential loan that will use an "income method" appraisal. Maybe an investor buying with cash would but it is my understanding that a conventional lender is always going to want a "comparison approach" appraisal.

  • Investor · West Bloomfield, MI · Member since 2009 · 358 posts · 306 votes
    12y

    You're absolutely right Robert, lenders will look at comps. I wasn't talking about how lenders look at junkers though, I was referring to their valuation for investment purposes.

    When I talk about junker homes I'm referring to homes in rental-dominated neighborhoods. They're bought and sold primarily by landlords who care about cash flow, ROI, NPV and IRR. It's different from nice homes that are in neighborhoods dominated by owner-occupied homes. Values for nice homes are driven by what other owner-occupants will pay, not what investors will pay per dollar of cash flow. Investors may buy some but pricing is dictated by the owner-occupant market.

  • Investor · Lucas, TX · Member since 2010 · 620 posts · 352 votes
    12y

    @Tom A. Ok so you are not talking about valuations by lenders. You said "they" and then you said appraisers so that is what I assumed. You are talking about how an investor values a junker. Got it. But I'm still a bit confused.

    This makes sense if the income valuation method produces a value less than comparable market sales. I can seen an investor putting in a lower bid.

    But if the income valuation method produces a value greater than comparable market sales then wouldn't the investor just buy from the pool of available properties?

    If I a missing something here please buy my last junker. It makes cash flow out the wazoo but comps for a pittance.

    Which I thought was your whole argument, that junkers will appreciate based on rent increases just the same as nice houses will. But that doesn't appear to be the case. The values of both houses are set by comparable sales. It doesn't make a difference if the buyers are investors or owner occupiers. Neither is going to pay more than there own metric dictates.

    I think this is why the nice houses appreciate faster, because that pool of buyers are not looking at income valuation metrics. Ever noticed how the nicer the property the lower the capitalization rate?

  • Involved In Real Estate · My City, NJ · Member since 2013 · 181 posts · 81 votes
    12y

    A vs. C, I think ease of management & values has more to do about the overall economy than it is to do with the kind of housing stock you own. When decent jobs are there, there is money to spend on rents, things are good everywhere.

    Nobody complains when the rents are dumping in on them, when the economy slowed & the jobs died off, everybody is hurt by it.

    There are pluses & negatives to both A & C range rentals. I remember around 2004 we Landlords were complaining that our good to marginal tenants were all leaving us to buy homes of their own & that will happen again when and if things finally recover. Meanwhile lower end tenants tended to stay put. With the slow down, even the lower end is rough renting, but is still easier to rerent than an upper end emptys (at least around here, nowadays)

    Junkers in bad neighborhoods do appreciate in good times (In areas where things bubble). I think most of us saw everyone jump on the real estate bandwagon in 2004+ speculating in R/E making money till the bottom fell out. People who knew nothing about R/E & rentals jumped in with reckless abandon. And guess what? It will happen again some day, not now, maybe not 5, 10 years, maybe 15? That will be my time to sell, then I will buy again after the next crash. At my age I've seen the cycles in R/E over the years from when I was a kid.

    Those junkers you see for sale now, see how much they sold for in 2005,6&7, then ask yourself if you'd like that in your pocket.

  • Plano, TX · Member since 2013 · 226 posts · 156 votes
    12y

    HEY @John Chapman

    Watch the Garland pot shots!

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