Complications of investing in big cities?

23 Replies

Hi all - I am new to the world of real estate investing. I have read a few books, and so have a decent "theoretical" knowledge base, but there is one key factor that has been largely overlooked in my studies: BIG CITIES!

I read the forums and look at examples in books, and lots of the buy and hold investors are giving examples and stories of the 2000 sqft single family homes they bought for 50, or 100, or 150k a piece. I live in Washington DC, and from what little experience I received from my mentor before he died, it seems impossible to find 1 bedroom units that aren't falling apart or in an extremely high-crime neighborhood for less than 200k. To give a general sense of what I have seen here, in middle-of-the-road neighborhoods a decent 650sqft 1 br/bath condo is running around 300k.

I do understand that in general, anywhere, higher prices come with the potential for even greater reward. But I try to apply something like "the 2%" rule (monthly rent = 2% of purchase price) to the situations I have seen and my knowledge just falls apart. For example, in this case where he bought the unit appraised at about 300k (actually bought for about 280k, because of some tricky building complications that ended up not being a big deal) 1 br mentioned above, the rent would theoretically be ~$6,000/month. But he felt lucky to get $1,900/month.

So I am beginning to get the sense that there is a disconnect between the theoretical knowledge I have gained from books and real-world deals in cities. Are there complications that frequently come about in a big city that aren't usually a problem in somewhere more suburban or rural? Are there different sets of numbers that I should be running? Is it treacherous for a first time investor to start in a big city? I suppose any information about investing in expensive markets and cities would be appreciated.

Apologies for the rambling and disjointed's just dawning on me that investing in the city might have major differences from elsewhere that I do not understand yet.

Many thanks!

@James Z.  - I see it as a personal preference.  I invest in Chicago - in the Urban A/B neighborhoods near transit and in the $300k range.  I like where I invest and am ok with the cash flow I get.  I feel I get a much greater appreciation gain, especially as the populations migrate back to urban environments the demand increases.  It's not like they have the space to build more housing (theoretically - they could always tear down a 3 floor building and put a 20 floor one) so I have been happy with the appreciation I have seen so far.  

That being said, BP has opened my eyes to higher cash flow markets.  So I am looking at buying out of state where I can pay $65k for a building that brings in $2k a month and diversity my strategy.  

I will say my units are easy to rent out.  I put an ad on postlets Monday night - do an open house showing Tuesday from 6-7 and get 3-5 applications by noon Wednesday and cherry pick my tenant and get a lease signed Wednesday night.  

@James Z. Hey James, where in DC are you looking?

I am also a new investor, also in Washington DC, and also facing the issues that you mentioned in your post. BP has been an integral part of my investor's education, but many of the principles here (mostly the rules-of-thumb) do not seem to apply in our market.

As I think you're finding, I would argue that the rewards aren't necessarily greater due to the greater price point. A $300,000 purchase here in DC may only yield 1,500-2,000 per month in rents, whereas the same rents in Baltimore might be had for a much lower price. I see that many BP members get $800/mo on a $60k purchase! This simply isn't the reality for us if we plan to invest locally.

I would focus less on measuring potential deals against rules of thumb that work elsewhere in the US, and instead measure them against your own goals in real estate. My strategy is heavily focused on cashflow, so if I can get $150/mo in profit per unit I am happy. I'll refinance for leverage and repeat. I started out by looking for properties meeting the 2% Rule, and I was looking for a long time!

Best of luck on your search! Please feel free to get in touch if you're interested in getting together sometime to discuss RE in DC.

@James Z. There is simply no way (or virtually no way!) that you will find 2% rule property in Washington DC. The 2% "rule" is fine, but there are some markets where it simply will not be applicable. DC is a perfect example.

Also, it is less about cities than it is "expensive markets." There is nothing wrong with this, of course, but don't worry about being "trapped" by the 2% rule when considering properties in such markets.

Treacherous is too harsh a word, but certainly more risky. It's not so much big cities, but big cities on the coasts. I live in KC, and it's not hard to find houses in OK areas around $40,000-100,000. I would certainly say it is much harder to buy and hold as the rent/cost ratio isn't as good when the prices are that high.

Have you looked into nearby areas like Baltimore or parts of Virginia where people may live at due to the higher costs of living in DC?

@Andrew Syrios  has a good point about buy and hold. Would love to hear what other DC BPers think about B&H strategy in DC.

Personally, I have been looking for B&H properties in stable, middle class areas outside of the 'hot' neighborhoods, but in the path of long-term expansion. Think 16th Street Heights and north, Woodridge, Deanwood, etc. The numbers don't come near the 2% Rule, but they beat the pants off H Street!

Thanks everyone for the replies.

It sounds like the 2% rule is truly inapplicable around these parts! Glad to hear I'm not just doing some terrible miscalculation somewhere.

@Brendan W.   I have primarily been looking in 16th Street Heights, Columbia Heights, and Petworth. Some along the Georgia ave corridor, seeing how things are changing around there. I chose these areas partially because I am local and can get about in those areas to see things in person the easiest, and partially because their price range seemed to match what I was looking for. 

@Scott Stevens   I am starting to look in the surrounding areas, especially Northern Virginia. I have kept a particular eye on the expansion of the Silver Line near Tysons and Reston, but have tried to not focus too much on that since I figure I best figure out investing before I figure out speculating! 

Which leads to me to my next question, which is somewhat related to what @Andrew Syrios said about rent/cost ratios...if I intend on being a buy and hold type investor, what benefit would investing in the city present over the less-expensive outlying parts? If the prices are more reasonable and I can get better cashflow by investing in Virginia or Maryland, is there any perk that might bring my attention back to the city? @Brianna Schmidt brings up that there is quick turn around for getting tenants, and the possibility for appreciation...but can those things or other city perks really balance it out?

I think this is an interesting topic. I have heard many people from California on this forum who invest almost exclusively for appreciation. If they happen to get cash flow, it is more of an added bonus. Appreciation in their market is so high that it literally turned average investors into very wealthy people.

I am not sure if appreciation plays that big of a factor in Washington DC, however I do know that you may have to look outside of the area for cash flow. There was a Bigger Pockets Podcast that went into that topic. The investor was from DC, but started buying property in Baltimore for under $30,000 each.

James some great questions. I was wondering exactly the same things. I own 15 properties in Oklahoma City right now where I used to live and have continued investing there because of the great cash flow. After 2 1/2 years in Italy I am moving to DC in about 2 weeks. I've been paying a lot of attention to the local market there and trying to figure out how to make it work for me. It seems really daunting right now. Since I've been a long distance investor for the last couple of years I'm thinking that I will be looking at Baltimore or somewhere else much further out. I'm not sure I can invest in something that offers little or no cash flow and hope that appreciation makes up for that. If you are a buy and hold investor it's not the best strategy anyway since you would have to sell again to see any of the rewards.

The big word in DC right now is "gentrification." In a sweeping generalization of the past few decades, the "left" half of DC's map has for a long time been considered wealthy, safe and profitable. Many parts of town on the "right side of the map", east of Rock Creek Park, or east of downtown, have not. 

Then within the past 10 or 15 years, a few key areas have absolutely exploded with development, bringing in fancy shops and restaurants, nightlife, and housing. I imagine if someone could invest quickly once they realize this is happening in an area, the appreciation would be worth it. Anyone that bought some property in Columbia Heights, the H street corridor, or the U street corridor right before this happened is probably pretty happy right now. 

But I feel like these epicenters of gentrification are not terribly large, and you have to really jump in at the perfect time. I moved into the northern end of Columbia Heights over a year ago. About 8 years ago, there were multiple murders directly in front of my doorstep. Now the area feels very safe, and very hip hipster bars are popping up along 14th street, heading north from Columbia Heights proper. The same 300k one-bedroom I mentioned above probably would have sold for half that ten years ago, but now that the initial explosion happened about a ten minute walk south, I imagine it will take at least a decade before the slow crawl of fanciness from Columbia Heights proper really shows any appreciation to the guy who bought it 2 years ago.

I suppose what I'm trying to say is that if you are buying solely for appreciation in DC, it's a possibility, but not in the same way that it might be in California, as Anthony said he had heard it was. The only area that I know of that is about to have one of these renaissances is the Georgia Ave corridor, and even then it's hard to tell how much of one it'll have.

The more I talk about this the more I want to turn my eyes to nearby Virginia and Maryland. I only have the resources to at max get two or three smaller properties when I really start this - and it sounds like if I throw those resources at DC I will get little cash flow and be in arrested development until that area hopefully explodes.

@James Z.  -  That has been my strategy.  I bought in areas that started to be gentrified before the boom knowing that when things picked back up they would be the first areas to start.  I also paid attention to proposed redevelopment plans and city initiatives.  I am up 130% in property value just in the last 2 years

@Sara Cunningham  , there is a quite a bit of this happening in OKC right now although the swings will never be as large as a DC or California.  Think Classen/10-Penn and there is the potential but who has the guts to go early...

@deborah b. funny, I am working with a group of investors.  they own almost a whole city block in that area.  they see something happening there sooner rather than later.

Deborah and Rhett I read somewhere, I think on here actually that the area you are talking about, Classen /10 Penn was looking like a good bet. I'm coming into town next month I might have to investigate.

It's not big cities specifically, it's DC. DC notoriously doesn't have good price-to-rent ratios for rental properties. All the DC rental property investors I know have bought out-of-state because of it. A lot of big cities are like that- LA, NY, etc. but little cities can have the same problem. So it's a market-specific problem. Your knowledge or what you've read isn't off. The 2% rule though is less common because fewer and fewer properties all over are hitting that 'guideline'.

Originally posted by @Brianna Schmidt:

@James Z.  -  That has been my strategy.  I bought in areas that started to be gentrified before the boom knowing that when things picked back up they would be the first areas to start.  I also paid attention to proposed redevelopment plans and city initiatives.  I am up 130% in property value just in the last 2 years

@Brianna Schmidt, a question for you on your strategy.  Where are you looking for these redevelopment plans and city initiatives - in the newspaper?  Or do you go to the town hall/city council meetings?  It probably depends on your market as to where these are advertised/discussed, but I'd love to hear more about how you do this...

Amanda - in Chicago we have wards and each ward has an alderman.  Each of them have websites and I get newsletters.  So I start my looking at prices in neighborhoods and see which ones I could afford then I set up the newsletters on about 10 wards and read them weekly.  I probably read them for almost a year as we were prepping to buy our first

@Anthony Gayden  

is talking about is alive and well in the inner city of Portland neighborhoods.. Not so much over in the couv. but one just needs to go to the sellwood, Mississippi, Laurelhurst , type neighborhoods and you see plenty of gentrification.  Also get ahead of were demographic groups that are high income and like nice properties are buying they tend to be clannish there is upside there as well.

@Jay Hinrichs  

 - You saw where I was going with my question :)  We have two rental properties in TN that are variations of the 2% rule but I'm always interested to hear about appreciation plays and how people find/decide.

I haven't looked much in PDX - only because I've been focused on TN acquisitions, but deals in that market aren't nearly as great as it was in 2011 when we first bought there.  So now I need to branch out.  Thank you for those pointers!

@Brianna Schmidt - thank you for the tip on wards! - I'm sure there's an equivalent in my area.  

I'm with @Jay Hinrichs  on this one. But I'm a little biased investing in the Bay Area in a big city ;)

I invest in nice streets in lower-income neighborhoods in the Bay Area with high rental demand and increasing rents, close to major employment centers, good commute, etc. I think rents will continue to increase as spillover continues from higher cost areas into these areas. I get just over 1% at purchase (~7X GRM), but I'm buying beat-up vacant foreclosures and fixing them up. Not move-in ready..

If you want to know what's more unique to a big city, I would ask myself: where are the jobs? how long are commute times? what demographics and income levels are living where? how much are property taxes? is there off-street parking? is there a yard for kids to play? park nearby? is a great resource to get an amazing array of information on demographics, employment, household size, commute times, bedrooms/unit, property type breakdown.. all census data and more.. 

@J Martin great tip on looking at commute times, has a table on it like this:

(Note this is the chart for my hometown, and yes people here complain about their 'brutal' 15 minute commute :)

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