Would you rather buy a $40k rehabbed rental in a C neighborhood or $55k in a B?

70 Replies

I'm curious about neighborhoods as it relates to turnkey/ buy, fix, hold purchases. Most of us have preferences for A, B, C, or D neighborhoods when it comes to investing and rule out the others. My hunch though is that especially when it comes to having other people manage the property and headaches that we really don't care as landlords about what neighborhood the property we own is in, but rather what the best predicted return on investment is. There seems to be a relationship between better neighborhoods and more rent with less destructive tenants and expensive vacancies, but also an increasing price that tends to go up at a higher rate than the rents. Assuming headache was not an issue, what would be the best long term ROI in a city with moderate economic and population growth? Let's ignore taxes and property management costs. All houses are rehabbed according to code and ready to go.

In this scenario would you rather buy a $25K SFH in a $500/mo D, a $40k in a $700/mo C, a $55k home in a $900/mo B, or a $130k in a $1200/mo A?

From those numbers, the D property would be the best return.

From my experience you always have higher cash flow in the "war zone" or D grade neighborhoods. The houses still command moderate rent, but are dirt cheap. You just have to control the situation and the tenants. It's more management intensive and that's why on paper they have better numbers.

I have a house in a D neighborhood that my cost basis in it is around $11,000.00 and I get about $235 cash flow from it. That's a great return on my investment, lots of cash flow, but it doesn't have much equity.

Justin Whitfield, Upstate SC Properties, LLC

You are forgetting something that is extremely important in answering the question.

Exit strategy.

With SFR in an A or B neighborhood, when I retire I can sell them off one-by-one to owner occupants.

With a portfolio of SFR in C or D neighborhoods, I may be limited to investors (or have to carry notes or do other things that cost effort and money.)

So for me, the answer is the B property at $55k, which comes closest to the sweet spot in terms of rent and exit.

The question is moot for me anyway.  $55k in New Hampshire usually won't buy a vacant lot, never mind a B class rental house.

Hi, the goals of your business determine what you buy and where.  You can make money in each of these neighborhoods but, what do you want?

1. stability -less headaches

2. higher cash flow

3. appreciation from long term buy and hold

4. less money out of pocket to get into the deal

5. return for your investors?

It really depends on you.

I second @Richard C.'s comments above.  'B' class all day long to give a nice mix of cashflow and somewhat more optional exit strategies.  

All great points. I currently have a portfolio 100% in the C class. Good cashflow, but the usual tenant headaches that come with it. Definitely long-term, not flips. I'd probably prefer starting out with B types if I could rewind, but still wouldn't trade my assets. I do plan to diversify a bit now. As suggested, each class has its advantages. I know if plenty investors in war zones that love their investments. Likewise, many in A neighborhoods that love their's as well.

Rafael Norat, RN Business Management | [email protected] | 908‑419‑3665

If you can finance it and have selling to an owner occupant as an exit strategy class B would be the winner.  C might be workable, but doesn't seem to be compensating you for the headaches and risks.

The class A likely has appreciation potential, but doesn't look to offer much on a cash flow basis.  If you can apply 50% of rent to financing - you are pretty much breaking even on leverage.

What I actually find interesting is to think that any home in the $55k price range is considered a B neighborhood?  $55k homes I would be willing to assume confidently will be a C at best area.  Who is selling homes TK for $55k that rent for $900???  

Obviously the lower the price the higher the ROI and cash flow may seem on paper but in all reality the more expensive home with less cash flow and ROI will out perform them almost every time. So if an investor is using conventional financing you should buy as nice as possible especially if you are buying long distance.

Medium buymemphisnow stacksCurt Davis, Buy Memphis Now | [email protected] | 605‑310‑7929 | http://www.BuyMemphisNow.com | TN Agent # 00321765

In Milwaukee there are quite a few renovated houses right on the MLS in the $40-$55k range that will rent for $900. However, I would agree with Curt that these houses are all in C class neighborhoods.

@Mark Shaffar

Great post Mark!  It's the debate I have with myself frequently looking into out of state buy and holds.  The "headache" definitely ways in that you cannot count on paper.  I'm sure as many have attested here that the higher vacancy rates and maintenance issues that come up in certain asset classes end up eating into the better cashflow in the Cs and Ds.  There is a lower barrier for entry into those classes which I'm sure other investors consider.

Since visiting a few of the Midwest cities the last month, my target are the B and greater neighborhoods for long term buy and hold.  However, what has intrigued me as of late are the transitioning C neighborhoods that border the B areas that have a potential for appreciation which I'm also looking into.

Ultimately, it boils down to tenant selection and the company that manages the property.  C and Ds cash flow better but even the best PM company can't control the quality of the tenant pool that rents in those areas and the "headaches" those properties come with.

Once again a great post!  When it comes to investing in different classes it really depends on your risk tolerance and your end goals.  From my experience I would never recommend anything under a C class property.  For someone keen on investing on a C class property I make sure they know the risks involved.  I would never even dare touch a D class investment.  A property at 25K to 40K  can end up being 50K to 80K when you have to consider the property going vacant, maintenance issues, or even vandalism.  

The most successful investment properties are usually A or B.  Even though an A or B class property isn't as attractive on paper compared to a C or D because of lower returns on cash flow ..you get a much more consistent return, better tenants, and a better chance to increase your rent on the tenant, as well as seeing stronger capital appreciation.  For my clients that are looking to build a portfolio..An A or B class investment is the best for a nest egg and they are usually priced for around 80K to 140K (B class) and 140K to 200K  (A class).

And always remember, if you are ever investing in a property ask for the vacancy rates, how well the schools are, unemployment rates, crimes in the area, average income of tenants, median home price in the area, population growth, appreciation rates, economic indicators for growth,etc.  When analyzing the area and price point of the property you can start to determine the risks and classify these markets will make much more sense.

@James Wise I totally hear you man. I am trying to monetize headaches, which sounds crazy, but the idea is assuming you had an awesome PM and you never checked your email or phone calls from said PM, would the realized cash return be better on lower neighborhoods? I think not, but I'm curious anyway what others say.

@Rafael Norat and @Leo B.

 I'm with you, I've had my share of C and now am looking at B and above.

@Darren Budahn

 and @Curt Davis

 I suppose we all have different definitions of B neighborhoods. By B I mean middle class workers, small, older starter homes well maintained, grass is mowed, low or no crime, roughly half owner occupied, in Milwaukee renting for say $875-$1150 selling mid 50s to low 100s. Great tenants want to live there and I wouldn't mind living there and raising a family.

@Ericka Parrott My broad question is what is the best long term ROI. A might have more equity growth and less cash flow. C maybe just cash flow. B a mix of both.

I had a house here in Houston that I would consider A-/B+ (prob more B+). It appreciated significantly and I sold to lock in the gains. I barely made any positive cash flow but came way ahead from an appreciation standpoint. While this worked out great for me, my strategy going forward is not to count on appreciation. I am now in the process of buying homes in other markets that will likely be C class neighborhoods. My focus at this point is cash flow. I figure after 7 years I will have made 2.5x my initial leveraged investment from both positive cash flow and principle paydown. All properties I acquire have property management in place so I am not dealing with the bulk of the issues, so really the return is all that matters to some degree. I am concerned about an exit strategy but by investing in cheaper markets I think my downside risk is somewhat limited and even if I sell near what I bought it for 7-10 years later, I am still making a healthy profit. 

@Mark Shaffar

This is where the grading scale is so broad.  You classify B as $50k-$100k and I am not saying that is wrong.  For example,  my company mostly sells homes in the $60k - $100k on average so I use a scale within those ranges.  Now I know there are some companies that sell homes for example $100k low end to $250k higher end, so would they classify a $100k home as a D when in my market I would classify it as an A?   I have to believe that a lot of the markets are similar meaning a home that I would sell for $60k would be similar in another market same price, similar rent and similar neighborhood.

Just a thought.  I only brought this up as your initial mention stated selling a home for $55k with rents of $900.  That is just something TK providers are not able to provide anymore. 

Thanks!

Medium buymemphisnow stacksCurt Davis, Buy Memphis Now | [email protected] | 605‑310‑7929 | http://www.BuyMemphisNow.com | TN Agent # 00321765

Originally posted by @Richard C. :

You are forgetting something that is extremely important in answering the question.

Exit strategy.

With SFR in an A or B neighborhood, when I retire I can sell them off one-by-one to owner occupants.

With a portfolio of SFR in C or D neighborhoods, I may be limited to investors (or have to carry notes or do other things that cost effort and money.)

So for me, the answer is the B property at $55k, which comes closest to the sweet spot in terms of rent and exit.

The question is moot for me anyway.  $55k in New Hampshire usually won't buy a vacant lot, never mind a B class rental house.

 That's true, except for the fact we can't always predict what a neighborhood will rate in 20-30 years.  If you plan to exit in 5 years, you can use your strategy.  However, if you plan to exit in 2040, there is no foolproof way to guarantee an exit sale price.  Yes, an A neighborhood will probably maintain its status, but all other classes are subject to change.   In midsize and large cities, gentrification is a constant movable beast.  And its evil twin (degentrification? is there a term for this?) exists, too.  25 years is a long time to try to plot out such movements.

Or maybe my ignorance is showing again.  :-)

Originally posted by @Mark Shaffar :

All houses are rehabbed according to code and ready to go.

In this scenario would you rather buy a $25K SFH in a $500/mo D, a $40k in a $700/mo C, a $55k home in a $900/mo B, or a $130k in a $1200/mo A?

 I'm changing the scenario just a bit.  Instead of turnkey, I'm assuming I'm all-in at those prices, but that I oversaw the work myself.  Sorry, that just makes me feel more comfortable.  Also, I don't think I could buy turnkey properties for those prices that had those returns in my area.  And, I'm going to have to tweak the numbers a bit, to fit my area.

I like the C range.  You avoid the tenants with different less considerate ways of handling life (I don't call them "headaches") of D properties, and you avoid the lower cashflow of B properties.  In my scenario, for C properties I'm collecting $675-$800 month.

My personal current investing model doesn't focus much on exit strategy. Right now, I'm more concerned with long term cash flow potential viewed as a component of ROI, rather than what a property might be worth in 25 years. I don't plan to sell any of my properties until I am a very old man, if then.

One day, I'll move into B and A neighborhoods.  When I do so, I'll do it with the intention of exiting in five years or less.  My little-investor mind thinks a C tenant is just as good as a B tenant, and if the cash flow is better in C, that's where I want to be.  Until I decide to slow-flip a property, then I'll look for B properties.

My concern with B neighborhoods is I'm not sure I could get a true B property all-in for $50K.  I think to generate $950-$1100/month, I would have to spend closer to $80k.  That spread makes it more difficult to justify the extra cost when I could get two properties for less than $80K that generate more income.

Originally posted by @Mark Shaffar :

I'm curious about neighborhoods as it relates to turnkey/ buy, fix, hold purchases. Most of us have preferences for A, B, C, or D neighborhoods when it comes to investing and rule out the others. My hunch though is that especially when it comes to having other people manage the property and headaches that we really don't care as landlords about what neighborhood the property we own is in, but rather what the best predicted return on investment is. There seems to be a relationship between better neighborhoods and more rent with less destructive tenants and expensive vacancies, but also an increasing price that tends to go up at a higher rate than the rents. Assuming headache was not an issue, what would be the best long term ROI in a city with moderate economic and population growth? Let's ignore taxes and property management costs. All houses are rehabbed according to code and ready to go.

In this scenario would you rather buy a $25K SFH in a $500/mo D, a $40k in a $700/mo C, a $55k home in a $900/mo B, or a $130k in a $1200/mo A?

 You are asking us to dismiss location of the property? D is war zone right? You want us to ignore that it is a war zone? Interesting... I would choose the B class neighborhood at $55K.  Why because I plan to hold for long-term and am hoping the B neighborhood would hold its value over many years. 

@Rhondalette W. I'm asking you to ignore headaches and monetize the investment:) This is just a thought expieriment.

@Randy E. and @Curt Davis please stop trying to get me to promote on the forums:)  I especially agree with Randy's earlier quote about the difficulty of predicting appreciation. I made a killing in Beijing, China with appreciation but I honestly just feel like I was lucky and in the right place at the right time.

I am surely not trying to get you to promote anything but rather to admit you are not selling $55k homes that rent for $900 per month.  

Medium buymemphisnow stacksCurt Davis, Buy Memphis Now | [email protected] | 605‑310‑7929 | http://www.BuyMemphisNow.com | TN Agent # 00321765

Originally posted by @Curt Davis :

I am surely not trying to get you to promote anything but rather to admit you are not selling $55k homes that rent for $900 per month.  

 Not these days. Not too long ago maybe - but prices have come up. 

2012 I bought all in for $30k, rents for $975. House is worth $80k now

@Bryan H.

Curious what market you purchased that in and with figures like that you could not have possibly purchased that from a TK provider right? Might have been possible doing it yourself.   Either way thats a solid deal, just dont exist like that anymore. 

Medium buymemphisnow stacksCurt Davis, Buy Memphis Now | [email protected] | 605‑310‑7929 | http://www.BuyMemphisNow.com | TN Agent # 00321765

Originally posted by @Curt Davis :

@Bryan H.

Curious what market you purchased that in and with figures like that you could not have possibly purchased that from a TK provider right? Might have been possible doing it yourself.   Either way thats a solid deal, just dont exist like that anymore. 

Sorry, no this wasn't TK. I bought a foreclosure in Madison Heights MI 

352 W Kalama Ave, Madison Heights, MI
I'm always stumped when it comes to classifying neighborhoods. I consider this a B- for that market,

@Richard same for me in MA. There aren't any 55k in my neck of the woods either.  I concentrate on A properties in A neighborhoods. The cost of entry is exponentially higher but I get great rents and for the most part great tenants. I sleep well at night too :)

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