I'm looking to purchase my first rental property and can't decide between two neighborhoods. One neighborhood is a C neighborhood but turns about 20% ROI where as there's a A/B neighborhood that turns about 10% ROI. Is the tougher neighborhood worth giving a try for a first time around?
If it were me it would be no question and I would go with the nicer neighborhood, especially if this is your first property.
@Beth Simmons I absolutely agree with @Aaron K. . Being a landlord is hard enough. You may hate it. And believe me, you'd rather hate it with nicer property in a nicer neighborhood. Not to mention that if you decide it is not for you it will be easier to sell. If you find it is a breeze then you can try better cash flowing neighborhoods. For me, as I've grown, and have other people managing, it has actually been easier to move into B and C neighborhoods as I don't have to directly deal with the headaches.
@Beth Simmons , I'd be surprised if those neighborhoods are exactly as you described. ie. 'A' areas are not known for achieving 10% cash flow. More like 3-5%. And you usually have to go to 'C-' or below before you get to 20% ROI. But your question remains a good one, even though it requires one of those "it depends" answers.
ie. What is your long term goal / exit strategy? Would you prefer an ongoing 20% ROI, while not expecting any increase in the value of your original outlay, or, would you settle for an ongoing 10% ROI, while counting on (uncertain) future appreciation that might compensate you for the other 10% that you could have been getting from day one?
ie. Do you prefer oranges, or apples? [Either way, find a good Property Manager]. My 2c...
Thanks everyone for your help. It's hard to walk away when you see the extra dollars but from everything I've heard on BP, the nicer neighborhood is generally recommended for the newbie (or even those more experienced).
I also hadn't thought of the appreciation value as I intend to be a buy and hold investor, but that's definitely a good point.
Let me compare two hypothetical scenarios for you. Numbers are rounded for simplicity
Scenario A neighborhood: Purchase price, 200k, downpayment 40k, monthy cash flow after ALL expenses $200, annual average appreciation 3%.
Scenario C neighborhood: Purchase price, 200k downpayment 40k, monthy cash flow after ALL expenses $400, annual average appreciation 1%
After 30 years, assuming NO rent increases, on Scenario A you would have profited 72k in rent, PLUS own a property free and clear worth 485k. On scenario C you would have profited 144k in rent, plus own a property free and clear worth 269k.
Thanks Eric. I had never run the numbers but definitely makes sense.
Run your numbers very conservatively on a lower-class property. On paper, it can look great, but in reality, you may end up finding out that turn-over/vacancy happens even more often than you accounted for. I would vote for the nicer property. 10% is good.
I agree with everyone else. It's unlikely a true "A" will get you 10%, the lower quality the property, the harder your landlording job will be, etc.
It can be hard to walk away from nice-looking numbers, but always remember--what's printed on paper is never an in-stone number. Not one single number ever printed on paper has to pan out or necessarily will pan out.
Check out this article I just wrote last week, and focus on #1 and #2-
There's cash flow as a requirement (or returns), but then there's the sustainability of that cash flow. If you can't sustain the predicted cash flow, you aren't winning. And inevitably, the minute you get into lower-end properties, the higher the risks become. They aren't always undoable, but it's riskier. As a new investor especially, that risk level should raise some red flags.
If you never actually get that 20% return, going for that cheaper property didn't do you much good.
Have to agree hard to see A area returning 10%