How to assess risk on rental property in low-income neighborhood?

9 Replies

Hi,

I'm thinking of buying my first rental property in a low-income neighborhood in Memphis called Frayser (38127). My question is, ASSUMING everything's fine AT THE OUTSET (good management company, no abandoned homes etc. on the street, house initially in good condition, vacancies are not an issue etc.), how should I assess the risk on the investment over the 30 years I'll be paying the mortgage?

Should I expect the rent I can collect to rise with inflation, or is it likely to steadily decrease? I don't expect the property value to increase, but how can I get any handle on the risk that houses on the street become abandoned and that it becomes harder to rent the unit?

Part of me wants to think that housing will always be in demand, particularly in Memphis where a large percentage of people rent. But the likelihood of the bottom falling out affects my bottom line so strongly that I would really like to have some sort of handle of how likely it is. Thanks so much for your time.

I would not recommend you buy in Frayser. Most investor who live her would stay away from that area. It would be exponentially more difficult for you to have a positive experience being out of state.

It's all about location in Memphis, and although the numbers may look good on paper, the buyer must be aware of where the property is located!

Thanks so much for your quick reply Stephen! Since you are in the area, would it make any difference if it is a newly flipped home? The management company has a 97% occupancy rate. Is most of the risk long-term depreciation and inability to find good tenants 10-20 years down the road? Higher than expected repair costs? Any insight you or anyone could provide for making decisions in low-income areas here and elsewhere would be appreciated. Thanks again!

Most of your issues will come from tenants. Properties in those areas have low resale values and it is very likely that whoever is selling the property is selling you an investment property at retail value. Assuming that you are buying at the right price, you may experience high tenant turnover and damage to the property. Also expect to experience vacancy damage as well, if the unit is vacant, people will often break in to steal and cause damage to the property. Again this is a generalization as I know investors who invest in low income areas and do very well, but it's worth mentioning here to double and triple check everything.

Daniel,

It's hard to say where a neighborhood is going. Especially when you are investing from out of state.

Good middle class B neighborhoods today are pretty likely to be C neighborhoods in 10-15 years.

In my market homes that were built in the 70's, 80's, and early 90's can be bought for around $100,000-$130,000.

The problem is people that are buying these older homes in that price range are just scraping by. They are buying with FHA loans and putting almost no money down, and have little to no savings. The problem arises when the 20-30yr old home needs a new roof or paint job, and these people don't have the financial means to make big ticket repairs and maintenance.

It's basically a bunch of people that should be renters are now homeowners thanks to federally subsidized loans. In all actuality they are still renting from the bank, but there's no landlord to make repairs and keep things in order.

Once the homes start looking bad the values start to slide and now there are people underwater and foreclosures stat occurring.

So yes there is a fair amount of uncertainty and risk associated with owning a home for 30 years.

I personally like to buy homes that were built in the 50's & 60's in neighborhoods that have already experienced a decrease in value. These neighborhoods have already peaked, declined, and bottomed out. They are centrally located in town and are safe/ not war zone neighborhoods.

I'm currently up to 5 single family homes and I can unequivocally say that I would never recommend owning rental property out of state.

I'd highly recommend turning every stone close to home before venturing away.

all of your return needs to be cash driven. Dont bank on appreciation. Lower margins and frequent issues should be expected.

@Daniel Tamayo

Take my advice, dont buy in Frayser or any real low income area if possible. I know calling an area low income is personal preference but you 9 times out of 10 will lose this game. There is only one turnkey provider in the Memphis area that has some level of success in hat area.

You being a long distance investor would be better to buy in a nicer area with slightly lower rent ratio, it will perform better long term.

First of all, 30 years is too long to hold on to these kinds of properties. If your cash flow cannot pay off the mortgage in 10 years or less, its not a good deal. Secondly, what is low income? Rents under $700 generally attract bad tenants. Above 800 is more decent in my experience. I like what @Ed L. said. The middle class is under a lot of pressure and B properties may turn C in 10 years. The C's will likely remain C's. So why not buy properties that hare already depreciated?

As for out of state, everyone has a strong opinion on that, but I own 8 out of state properties. While they have had their share of issues, overall the portfolio is profitable and will pay off in 10 years or less. But you can get burned. I have a good property manager (he is not cheap but he is good) and thats key to the out of state investments. To know what kind of area it is, ask a few property managers, not the seller of the property. They know the scoop on neighborhoods.

@Anish Tolia

That's a good point regarding the time horizon for lower income properties. I think a lot of people fail to realize just how long 30 years is.

That's my entire life + 4 years lol....

I never base my rental return rates on a mortgage longer than 15 years.

In a low income neighborhood you are going to see much more turnover. We do the happy dance when our tenants stay one year. Does the property manager have experience and a track record in these areas? It is draining to deal with turnovers and the constant tenant drama and repairs. You will be paying for the same items and repairs over and over, low income tenants are incredibly hard on appliances and the property in general. There is money in it, cash flow can be great. We own 5 low income properties and three are fantastic. The difficulty is predicting which ones will be winners and figuring out what to do with the losers, and being able to spread that risk.

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here