Potential deal and rental buying criteria in high priced markets

10 Replies

Hi! I'm a newish wholesaler (I've completed a couple deals) in the Sacramento area, and I frequently run across houses that are too nice (and expensive) for the typical flipper on my buyers list. I'd like to figure out how to sell wholesale leads like this to landlords, but I don't understand how to analyze rental property in high price markets. 

The thing is, I've read the Bigger Pockets Book on Rental Property Investing, and listened to enough podcast to know that the general wisdom around here is that you don't invest in properties that don't cash-flow. Most of the houses you can buy around here, even at a discount, don't cash flow if you include all of the oft-forgotten expenses such as cap-x, property management, and maintenance. So, when I try to analyze based on cash flow, every property looks bad, but I know there are investors out here, even professionals, that own SFR rentals.

Here's an example deal. I'm talking to someone right now who wants to sell a property for 168k, and it probably needs 20k in work, so let's call acquisition about 188k. Market rent is $1200. ARV is only about 210k, so the margins aren't great enough to flip it. With 20% down, PMI and taxes would be around $870/mo, so setting aside $100 for maintenance, $100 for cap-x, $100 for property management and 10% for vacancies, we're pretty close to breaking even, but not really positive cashflow.

So my question, especially directed at professional landlords in high price markets, is this: what do you base your purchase decisions on? If not cash flow, maybe cap rate? Who's buying rental property that doesn't appear to cashflow? And how do I find these people? I'd also be interested in talking to any local landlords who are actively looking for more properties.

In general, I like tweener properties that are too expensive for the flippers, but also not nice enough for a home owner looker for turnkey. I've bought three properties like this off the MLS in the last three years.

With that being said, though, that property by the numbers is not really investment grade, even for me. 1200/188k = .64%. I can find better deals than that on the MLS. You also didn't include water/garbage which a lot of landlords still pay around here, so that's another $150 cost. (Unless you're confident that 1200 rent is with the tenant paying).

When do I see people buying for that rent ratio, it's often in nicer areas, where they will high grade tenants to at least keep the vacancy and repair numbers lower.

Those buying properties too high priced for positive cash flow do so to either "park" cash or speculate on appreciation. They already have a high level of wealth and therefor have no interest in a cash flow investment. 

There are however also many investors that have no investment knowledge what so ever and do not understand expenses. There is a sucker around every corner.

I have some experience in this area, and Derek is right.

Typically the more expensive the SFR yield lower return. The reverse is also true, less expensive SFR investment property will yield higher returns.

That being said, I have assisted clients who invest in higher priced single family homes for a number of reasons. It might be close to where they live, they already own multiple property nearby, and/or they prefer working with a certain type of renter. I have also personally invested in higher priced single family homes knowing I will get less return because I have contacts that handle high income professionals who are relocating on a medium terms basis (3-5 years). The rent is guaranteed, and there is very little effort needed on my part.

In response to the first part of your post. The more expensive/nice flip property are often too risky/time consuming for the typical flipper. To account for the added risk, there has to be a much higher profit potential. I also flip property at a more expensive price point, although I have to be picky with these types of purchases. 

@Derek Daun it sounds like you are exactly the sort of buyer I'd like to add to my list. I run into a lot of these "tweeter" properties, and usually I just pass I them. What kind of rent ratio have you been able to find on the MLS?

@Thomas S. yes, I have to agree about the suckers. One of the reason for my question is that I'm hoping to understand how the professional landlords in the area make buying decisions. I know there are a lot of accidental landlords (I'm often talking to them because they are in trouble and trying to sell) but on the selling end of my own business, I don't no think I can rely on these sorts of landlords as buyers. 

@Stephen Riggs thanks for your insights! Are you currently looking for nicer rentals to purchase? 

@Zachary A.

I just closed on a duplex for 250k that I'll rent to the current occupants for total of 1800 without doing much work, so .72%. That's giving the current occupants a discount as I could easily rent for 2000 if I wanted to put it on the market, probably more. So that's easily potential of .8%. (That is with me paying water/sewer though). But this is in a neighborhood with excellent appreciation potential.

The one thing I should add is that I look for specific deals on the MLS, intentionally buying in the Fall by picking through the properties that fell out of escrow during the peak season, usually due to the buyer not having their act together. So I am buying a little better pricing than straight up MLS purchases. For example, the place I just bought for 250k could have sold for 300k if they had taken proper pictures, didn't let the tenant drive away buyers, and had a more hands on realtor/property management company.

The more I think about, the more I see your deal as not being bad if the tenant is covering all utilities. It depends on the neighborhood though. I wouldn't want that slim of margins in North Sac, but I'd consider it in Oak Park.

find ways to get creative and generate more cash flow. I too live in oak park and am actively looking for places near by. 

@Zachary A. : My thoughts on this subject as someone who's lived in the SF bay area for close to 40 years:

It's currently very unfashionable in the REI community to go for appreciation plays, but to be honest, before I found BP I didn't even know there was any other strategy and I think that goes for many native Californians. Almost anyone who's owned real estate in CA for any amount of time (primary or investment) has probably made a ton of money through appreciation, and usually in the 6-7 figure range. I'm guessing that a majority of would-be investors in CA would be more excited by appreciation potential rather than trying to squeeze out a 4-cap in Sacramento.

I'm no longer one of them, but I think you do yourself and them a dis-service by classifying them as "suckers." It's simply the strategy that works in CA, with 1 major exception (2008! arg!).

That said, my advice to you would be to sell the appreciation story rather than trying to pump up yield. Hopefully, you're finding deals that are at least potentially high appreciation if they are lower yield. If they are low yield, and low appreciation, then yeah, you're gonna need to find yourself some suckers. :)

Hope that helps!


P.S. Sacramento is actually currently a high appreciation market in the A and B areas. I just traded out of a property in West Sac to move into cash-flow markets. I thought I made a killing until I watched the zillow estimates go up another 50K after a few months after I sold it. :)

Thanks @James Kojo ! Many of the areas I look at are on the outskirts of Sacramento (that house I mentioned as an example is in Placerville), but I think those areas usually have good chances for appreciation since the city is always growing outwards.

@Derek Daun , that house I mentioned is in Placerville. I'm not sure yet about the condition and required repairs, I should be going out to see it this weekend. It's possible the repairs will be less, and market rent may be more ($1300 according to Zillow) than I quoted. PM me if you think it's something you would be interested in. 

Some investors might be ok with initial investment close to cash flow even in certain locations. They are thinking longer term outlook and understand for total profits (cash flow + equity) Sacramento is in top 10 nationally since 2000. 

Good luck!

Hi Zachary, not sure how your deal worked out in Placerville several months ago, but houses up here (I live in the Placerville area) are getting scooped up so fast right now. What kinds of houses are you currently looking to purchase/wholesale?

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