I have a question that maybe some of you more seasoned buy and hold investors might be able to answer. A lot of the forums/webinars talk about a minimum 12% cash on cash return on rental property investments, but for someone just starting out and living in Southern California, a 20% down on a half a million dollar “deal” isn’t easy to come by, it seems the numbers never add up. But then I look at 3 bedroom single family homes in cities like Detroit MI and Cleveland OH going for $10,000 or less, bringing in a monthly rent of $750 at minimum, why aren’t all buy and hold investors looking for cash flow buy up in these areas? Is there a reason why these properties aren’t moving? Buying a $10,000 property in these slow appreciating markets outright and renting it out for $750 while living and working in Southenr California seems like a killer return to me, but am I missing something? Thanks for the insight BP peeps!

Actually a ton of buyers in CA are buying out of state and especially in the midwest it seems. I've been looking at Cleveland myself too..but you aren't going to find a home for $10,000 or less that is currently rented for $750 +. 

The properties are going to be in rough areas too, where it can be hard to collect rent. Vacancy rates are usually much higher in these areas.  If it takes you a while to rent out the property that cuts into your cash flow. Crime and drama higher. 

These homes are usually very old too so can require a lot of maintenance. One big expense could wipe out your cash flow for a year or more. 

There are people that specialize in the very low end rentals but they usually live in the area and know it well. 

I don't see people doing it from out of state successfully.

There is no secret sauce when it comes to real estate. Just like life itself. If you're buying a home for $10000 here in Cleveland, 99% of the time is beat up, needs extensive work, missing mechanicals. You will need to invest a lot of capital into the property to be able to rent it for $750/month. 

You're looking at a min of $50,000 for a home that's in a decent C area and rentable 

@Abed Asghar You are correct in the fact that the west coast makes very little sense for buy and hold investors unless you can put significant time and energy into drumming up leads and finding deals. The Midwest is an excellent option for investing but you also have to be very careful. Any house in these areas that is priced below $30-40K will be in D class neighborhoods. Even if these homes are marketed as "Turnkey" they are not appropriate investments for out of state investors. If you lived in those areas and this was your full time job, to maintain and collect rent, you MAY be able to make a go of it. The numbers look great on paper, but the long term track record of these properties is terrible with tenant turnover and repairs eating all your supposed cash flow. Investing out of state provides a fair amount of hurdles to overcome, but there are many opportunities for investors. I'd be happy to share my experience and provide more details if you have more questions.

@Abed Asghar Here’s my suggestion: Take a weekend and buy a couple of plane tickets and hopscotch around a few neighborhoods in different cities with $10K homes. Fly back to Los Angeles after having paid $3K for flights, hotels, and rental cars knowing it saved you from making a bad decision :)

Thank you for the insight guys @Jeff Wallenius @Andrew Johnson @Joseph M. Eye opener for sure! Would a good buy and hold deal be something like a seller financing property within 10 minutes of a city like Memphis TN, Birmingham AL, or other similar cities in the South and Midwest?

Finding a buy and hold with seller financing will be difficult as you are an large distance away. Seller financing if found is usually snatched up by local investors.

@Abed Asghar A lot of this will end up breaking down based on the scale you want to achieve.  Let's say you have $25K to invest and that could pay for 25% down on a $100K rental.  I, personally, would opt for a $100K rental in most situations because you'll get a materially better tenant, likely be in a better area, etc. that all of those $10K-$50K properties.  Since you won't live in the market there's benefit to having something that's not dredging up tenants from the bottom of the barrel.  But, for my example, it really doesn't matter.  

$25K w/ 12% CoC = $3000 per year

$25K w/ 10% CoC = $2500 per year

$25K w/ 8% CoC = $2000 per year

So the "awesome" vs. "horrible" CoC deal is $1,000 per year. That means that your $100K property only has to appreciate 1% more per year than your "depreciating market" in order to break even. Not to mention it breaks down to $83 per month. I had dinner with my wife last week, it cost me more than $83. I'd give up that monthly dinner (if I had to) to own an 8% CoC property that's in a better area instead of a 12% CoC property in a "depreciating market".

What's more, you likely haven't factored in travel costs to your CoC return. Let's say you're pragmatic and want to visit your property twice a year just to keep an eye on it. What's the difference in flight costs if you're going to Utah, Arizona, Idaho, New Mexico, etc. vs. Ohio, Michigan, etc.? I don't know the answer but it certainly isn't "zero".

I'm not saying that seeking out 12% CoC returns is a bad thing. It's not. But it's better for you to establish your investment parameters first rather than using someone else's arbitrary metrics.

Or, to put it another way, you could offer to give me the $10,000 home FOR FREE and I wouldn't take it.  Truth be told, I'm sure I could find homes listed for $50,000 that I wouldn't take (to buy and hold) for free.

@Abed Asghar - Search BP hard and you will find answers to all your questions. Choose any cash flow market and search properties sold way above comps, you will find 90% of the  buyers are from CA . I highly suspect $10K properties bringing $750 rent exist and are sustainable. Buy @Michael Swan lunch and pickup his mind on numbers.

Good Luck

Vivek 

Originally posted by @Andrew Johnson :

@Abed Asghar A lot of this will end up breaking down based on the scale you want to achieve.  Let's say you have $25K to invest and that could pay for 25% down on a $100K rental.  I, personally, would opt for a $100K rental in most situations because you'll get a materially better tenant, likely be in a better area, etc. that all of those $10K-$50K properties.  Since you won't live in the market there's benefit to having something that's not dredging up tenants from the bottom of the barrel.  But, for my example, it really doesn't matter.  

$25K w/ 12% CoC = $3000 per year

$25K w/ 10% CoC = $2500 per year

$25K w/ 8% CoC = $2000 per year

So the "awesome" vs. "horrible" CoC deal is $1,000 per year. That means that your $100K property only has to appreciate 1% more per year than your "depreciating market" in order to break even. Not to mention it breaks down to $83 per month. I had dinner with my wife last week, it cost me more than $83. I'd give up that monthly dinner (if I had to) to own an 8% CoC property that's in a better area instead of a 12% CoC property in a "depreciating market".

What's more, you likely haven't factored in travel costs to your CoC return. Let's say you're pragmatic and want to visit your property twice a year just to keep an eye on it. What's the difference in flight costs if you're going to Utah, Arizona, Idaho, New Mexico, etc. vs. Ohio, Michigan, etc.? I don't know the answer but it certainly isn't "zero".

I'm not saying that seeking out 12% CoC returns is a bad thing. It's not. But it's better for you to establish your investment parameters first rather than using someone else's arbitrary metrics.

Or, to put it another way, you could offer to give me the $10,000 home FOR FREE and I wouldn't take it.  Truth be told, I'm sure I could find homes listed for $50,000 that I wouldn't take (to buy and hold) for free.

Someone please give this man an award and sticky this response. 12% gets you in a C area and 8% get's you in a B area. I'm taking  the "horrible deal" investing in a better area with better tenants and less headaches every time.

@Abed Asghar

I agree with @Joseph M. Some other things to consider as to why houses are so cheap: property taxes are owed so you want to look into that and also the condition of the house is most likely horrific. All the best to you...

Jorge

@Abed Asghar another thought . If you are investing somewhere that you don't expect to appreciate or think it might actually depreciate why not just be a lender and now have all the headaches to deal with ?
Or investing in notes .

Investing out of state in Detroit, CLE, Cincy, KC, etc without being from there, having a family member there, or having a very good contact (like a friend who stood-up in your wedding type contact) is a recipe for disaster. You can get better ROI going to your local strip club. If you do decide to come into the MW market, avoid the Turn Key Providers, and bump up from $10K to $30K...If you get comfortable and know the market drop down, take the riskier stuff.

Yep, there's one major thing you're missing. The reality of those numbers actually panning out. 

Good cash flow numbers with "low" (compared to SoCal) entry prices are very feasible out-of-state. But when you get into something like $10k properties, there are a multitude of potential problems and reasons those advertised numbers will never actually pan out. Namely, the quality of tenants that quality of property will attract. Bad tenants can cost you a fortune (and your entire investment, if you're not careful). 

So you're looking at two issues in what you present:

1. Low-end properties
2. Depreciating markets

The first is the major thing for the tenant quality. Bad tenants can lead to extreme vacancy lengths, eviction costs, damage costs, no rent payments, etc. 

The second, which is the subject of your post... The risks in investing in depreciating markets are, but not limited to:

• Tenant quality (may not be great)
• Size tenant pool (potentially decreasing)
• Risk of being forced to decrease rents (may turn your cash flow numbers into losses)
• Exit strategy (loss of property value, fewer selling options, etc.)
• Loss of property value and loss of rents (point of investing is to actually profit...)
• May not be able to survive a market crash

Hope that helps! I live up in Venice and invest out-of-state, and as I said, it can certainly be done and you can get great numbers. But the ones you're presenting are on the major risk side of doing it.

Originally posted by @Abed Asghar :

I have a question that maybe some of you more seasoned buy and hold investors might be able to answer. A lot of the forums/webinars talk about a minimum 12% cash on cash return on rental property investments, but for someone just starting out and living in Southern California, a 20% down on a half a million dollar “deal” isn’t easy to come by, it seems the numbers never add up. But then I look at 3 bedroom single family homes in cities like Detroit MI and Cleveland OH going for $10,000 or less, bringing in a monthly rent of $750 at minimum, why aren’t all buy and hold investors looking for cash flow buy up in these areas? Is there a reason why these properties aren’t moving? Buying a $10,000 property in these slow appreciating markets outright and renting it out for $750 while living and working in Southenr California seems like a killer return to me, but am I missing something? Thanks for the insight BP peeps!

Well, it depends on where you are looking in those areas. Are you saying the property is $10,000? If so, GOOD LUCK! You will need to do $50,000 in repairs and renovations most likely. Also, if they are located in C or below neighborhoods, you will have a difficult time finding a well-qualified tenant. Ones that will last long and pay their rent on time. 

Yes, it is true many investors from CA invest in the Midwest. However, they make sure to invest in areas that will actually give them a decent ROI and not just look good on paper. Many of the suburbs in these cities are where you may want to look. Properties still less than $100k but less time consuming and fewer headaches.

@Abed Asghar .  I love the numbers of buying for $10k and not needing a rehab!  Sounds great.  I know guys who live in Indianapolis, IN and Jackson, Mississippi that put a lot of work into finding deals for $10k themselves and doing owner financing as they sell them.  They bring on investors sometimes.  They spent their whole lives there.  I have been having the envy of those markets.  

I have my brother and a realtor as boots on the ground in a market in Georgia.  There we can get properties for $50k and rent for $1000.  It has been a very stable market.  Good luck.  

I don't think the difference in C class and D class is 1k a year on paper for the same 25k investment. I'm going to say on paper your CoC is even greater on the D class stuff.

The problem is the numbers don't reflect the real expenses because turnover is much higher. Collections are much worse. Repairs and make ready are much worse.

Thats just how it works.

But the real reason you shouldn't invest in D areas is that you're limiting the real value of investing in real estate!

There are 4 ways that you make money on real estate.

1) Equity capture. Assuming you buy right (i.e. 70 to 75% of the appraisal value), you are gaining a nice chunk of equity when you get a house. That goes directly to your net worth.    There's not much equity to be had in a 25k house. If you're buying it for 25k, its probably only going to appraise out at 35k to 40k. 

2) Rental income. Here is where the lower end houses look great on paper compared to the nicer ones. But the reality is the repairs, collections and turnover costs will eat more of that paper profit up than people realize.  But I've seen some people manage the heck out of that stuff and make some really good money so there is definitely some income to be had.

3) Principal paydown. If you can even find a lender to do these loans, the reality is there isn't going to be much, if any, principal paydown on these types of homes.  I guess technically if you could get a 20k loan and amortize over 5 years, you'd get some. But only for 5 years, After that, nothing.  Versus a 100k loan, where you may be getting 200/mo or more.  That adds up when you have 10 homes or 20 homes.

4) Appreciation. You're not getting a lick of appreciation on 25k or even 50k homes for the most part. Now compare that to the 130k or 140k house another investor grabbed for 100k, they're getting 3 to 5% on 130k price? Thats 4 to 6k a year in apprecation. Again, that is going to be extremely dependent on the area.

But those are the reasons why investing in those 30k to 40k homes is not going to be the best investment in my opinion. You're going to limit the returns to the rental income. And you're going to have to deal with some really ugly areas where vacancy, collections, high turnover and higher repairs may limit your rental income far more than you'd want to believe.

Instead, buying in a nicer area where you'll get all the benefits of how real estate makes you money - equity capture, principal paydown, appreciation and rental income, seems to me to be a more preferred model.

That being said, I'm sure some investors in california and other areas like it who bought solely for the appreciation play have become filthy rich.  So that can work too and maybe far better and quicker than buy and hold on the bread and butter houses.   But that has its own brand of risk - most notably the fact that a lot of that stuff won't cash flow so you're having to feed your bet and hope it hits before you run out of money.

What I don't see is any way to scale the appreciation play model like you can with the bread and butter buy and hold stuff. How do you buy 10 800k houses and feed the losses for several years?

Originally posted by @Gary Olsen :

@Abed Asghar .  I love the numbers of buying for $10k and not needing a rehab!  Sounds great.  I know guys who live in Indianapolis, IN and Jackson, Mississippi that put a lot of work into finding deals for $10k themselves and doing owner financing as they sell them.  

That's pretty much the only exit strategy for houses that cost 10-15K. They generally do rent-to-own deals but I'm not sure those are legal under Dodd-Frank. 

@Susan Maneck , I hear you on the Dodd Frank.  There are ways of doing it legally.  Some people use a licensed loan originator to take buyers through the income qualifications.  In other deals we do a lease with a separate option.  The lease cannot mention the option.  We do 2 year leases renewable for 10 years.

Detroit is a great market to invest in. I'm here witnessing it. Also reading articles that imply that Warren Buffet and many others are investing here as well says something.

@Abed Asghar There's a very good reason not to be buying properties like that. $10,000 properties are in horrible areas. They might look good on paper, but I guarantee they won't perform. Just ask yourself what kind of tenant is willing to live in a neighborhood with $10,000 homes. They're the people that don't pay rent, deal drugs out of your house, leave in the middle of the night with no notice, destroy the place and strip all the copper on their way out. Prices have been rising in most good markets and it's now awfully hard to buy in good markets and good neighborhoods for under high $60k prices. As a example, 3 or 4 years ago, you could buy a turn key in a decent C class neighborhood for mid to high $4OK range. Today, that same property is selling for high $60K.