Cleveland, OH · Member since 2017 · 161 posts · 38 votes
I see more and more investors buying 10k SFR's in low-income areas. They put 5k-7k into rehabbing the house, and renting it to Section 8 for a nice, consistent ROI. I personally know 3 people who do this. They actually never even step foot on the properties they are purchasing, and they are all doing very, very well. A friend of mine let me see the numbers on one of his deals. Here it is. $5000 purchase. $7500 getting the home Sec 8 ready. Gross rent is $800. Property taxes are $100/Mo. Insurance is $60/Mo. Water+Sewer is $80/Mo. Vacancy/Repairs/CapEx $200. Rental Registration $3/Mo. Lawn, trash, snow, are not paid for. Taxes include Trash removal. PM is $75/Mo. Expenses- $518/mo. Cash Flow- $282/Mo. No mortgage, really not losing anything during turnover periods, and I think that CapEx is more than conservative. 3br 1 bath. 1200 sqft. Also I would like to add that he does NOT rehab the houses himself. He has bought and rented 2 houses per month, for the past year. Curious on what your opinions are, and why you do or don't like this strategy.
This is exactly what my mentor does, and he makes insane amounts of money! I think that model works A+++ if you have A LOT of units, because there will be some bad apples, so I think he had 100 houses, 1 eviction isn't a big deal, but if you are starting with say 5 houses, 1 could hurt, so I think scale is the most important factor with that business model.
We do a modified version, normally buy $15K, and instead of $7K in rehab costs, we will do $15K, and make the houses look nice and updated. Our houses look gorgeous, and we never have a problem renting them out. You just have to define your business plan, and make it work for you!
He told me "These houses aren't always cheap because of their condition, but because of their location. Other investors wouldn't touch these properties, and that is why I make so much money doing it."
This is exactly what my mentor does, and he makes insane amounts of money! I think that model works A+++ if you have A LOT of units, because there will be some bad apples, so I think he had 100 houses, 1 eviction isn't a big deal, but if you are starting with say 5 houses, 1 could hurt, so I think scale is the most important factor with that business model.
We do a modified version, normally buy $15K, and instead of $7K in rehab costs, we will do $15K, and make the houses look nice and updated. Our houses look gorgeous, and we never have a problem renting them out. You just have to define your business plan, and make it work for you!
@Joshua Hollandsworth so the magic here is buying in really bad areas? How long have your friends been doing this? If they have been at it for years, and I mean 5-10 years or more, then they might have found something for you to look into. If they have been at it for 6 months, I would be VERY cautious. This is also renting in non desirable areas and if your aren't even viewing the house, how do you know anything about it, or the location?
Seems risky and I am sure there are experts who will be along soon, however if I were looking into rentals, it would not be such low cost, "bad" area homes like described.
@Brian Pulaski All 3 friends of mine, that I know who personally do this for a living, have a 3rd party who takes care of everything. Viewing, showing, rehabbing, renting. I understand what you're saying. Jesse Wright. Look him up on YouTube. He breaks down this entire business model. Buying in bad areas has many pros in my opinion. Here are the top 5. Number 1) The home can not depreciate during a market crash, and if it does, who cares? Low income rentals will be THRIVING. And You are only buying for cash flow. 2) Deals are endless, because other investors are "cautious" 3) 15k. Come on. NO BANKS. NO CAPS. NO GUIDELINES TO FOLLOW. 4) During Turnover Periods, you may lose $150/Mo on taxes and insurance. On a 350k rental, you are going to be hurting during turnover periods. Also, during a crash, depreciation will really, really, really hurt. 5) 25%+ ROI's. That's just how I look at it. The main cons are easy. House will be hard to sell. Area is dangerous. etc. I guess everybody views neighborhoods differently. What I consider a bad area may be "undesirable" in your book. When I say bad, I am not referring to War zones. Just distressed, low-income areas.
I don't touch "the hood" and really don't look at the two largest cities in my area because of the pockets within. If you want to work your *** of to get people to pay and are willing to spend time fixing problems in the 70 year old houses, have at it. It might not be a bad return on good years, but cap ex can kick your butt over time and I don't have the time to deal with all of that.
I would leave those homes to the experienced investors or really learn how much work those houses are before getting in yourself.
Its a great strategy as affordable housing is needed everywhere. Its lots of negative stereotypes about lower income areas and its a huge disservice to people in general to broadly and negatively paint an entire community. That being said, screening is essential in all rentals. Therefore, have an intact screening process that allows one to get good tenants. Most areas have housing educational classes for homebuyers who want to purchase in the next 3 to 5 years.These are great places to look for tenants or advertise one's housing stock. Also, most people dont want to lose their section 8 vouchers as its a long wait to get approved. Most of the time when I see bad housing in low income areas, the problem is with the absentee landlord who lives 20 - 50 miles away and is only concerned about a paycheck. Most of the time, the landlord dont provide the same maintenance as if the house was located in a more affluent area. Emergency repairs in low income areas don't give the same attention from slumlords. Whereas affluent area rentals maintenance issues are addressed "Johnny on the spot!".. So, if a person screens properly, provide a decent clean rehab, don't look at and treat the tenants like they're animals, provide proper maintenance, and visit their property periodically, then its a win. You may have slightly more evictions, but if you're providing quality housing, the best tenants will seek you out...
@Lee Lockhart Excellent points made! Thanks for the input. @James Woodrich I won't be chasing rent when they are on Section 8. People also told me I would hate running a rooming house in the hood, But my tenants are great, and cash flow is amazing. It's all about screening. Sure, I have to kick one out every now and then. It's all part of the job. I guess I look at it as a business, rather than an investment. I can't get a concealed carry because I'm only 20. But it's on my list! Most of these areas aren't nearly as dangerous as they are made out to be.. Thanks for the advice!
The problem I would have is that those properties are generally worth very, very little themselves. Generally, they get eaten up by CAPEX costs or tenants tearing up the houses. They work for a while until they stop. At least that's what I see a lot.
@Andrew Syrios That's what I'm thinking. However, I see in certain markets investors are buying sub 20k houses, rehabbing, and selling turn key to other investors for 50k-60k. I think there is still equity to be captured. I think if you stick to a specific niche, it might still work long term. If you make a rule to never purchase over 1200 square feet, you can better calculate CapEx, and It should be lower due to the size of the house. Definitely a good point though. Thanks for the input!
There is a difference between “less expensive” and “dangerous” neighborhoods. We have been successful in making nice homes for people who live in these areas. You can really turn around a neighborhood by renovating the eye sores. Profitable too
@Lee Lockhart Excellent points made! Thanks for the input. @James Woodrich I won't be chasing rent when they are on Section 8. People also told me I would hate running a rooming house in the hood, But my tenants are great, and cash flow is amazing. It's all about screening. Sure, I have to kick one out every now and then. It's all part of the job. I guess I look at it as a business, rather than an investment. I can't get a concealed carry because I'm only 20. But it's on my list! Most of these areas aren't nearly as dangerous as they are made out to be.. Thanks for the advice!
If you decide to deal with people on section 8, make sure you follow up with them to make sure they get their paperwork in when it is due. I know someone who rented to section 8 tenants before. He got into a situation where the tenant didn't file their paperwork on time and he lost rent for a month since section 8 wouldn't back pay rent. The tenant really didn't have a way to pay it back to him so he had to figure out if he was going to evict or try to work something else out.
This was MN so I'm not sure it if applies to other states but it is something to consider.
The problems most people have in the slumlording are as follows:
-In poor areas it is not easy finding someone who is willing to properly the property for a reasonable fee. I would be surprised if you could find someone in North Minneapolis who would manage a property for 10% of rent. In your instance this would be $80, you have someone listed who will drive into these cities regularly for $75 per month. These areas typically have higher turnover and leasing the property ends up being more work.
-These places are hard to sell. That is also why they are listed so cheaply. You can get in cheap but these places don't appreciate. That means you will not be paid back for any CapX expenses so a new roof, furnace, etc will really throw off your return on investment, even if holding in the long run.
-Section 8 problems are real, I have missed rent in the past because of missed paperwork. Unless things have changed they don't pay back pay. And trying to make the tenant pay if this happens - good luck! They don't have any income. At the same time you will run into people who feel entitled and feel they deserve more. Expect requests to add picnic tables and other upgrades which do not make sense if you plan on self managing.
-Financing - These properties cannot be financed and because the value is too low. You will always be invested 100% cash. You mention that one person is doing 2 per month - lets say the all in cost is $15,000 each, that is $30k cash per month to get $400 in cash flow... Then you have a crappy property that you will likely be stuck with for a while. Why wouldn't you just put $30k down on a multi-family or a couple single family properties out of the hood? It sounds like these are long term hold investments and investing in better properties will give you a potential for appreciation.
-Tenant expectations - in my experience the more expensive the rental unit, the better quality tenant I get, and the better shape the property is kept. When you have someone who is getting assistance, it is likely that they are also walking in with assistance on their lease deposit. It isn't their money, they are less inclined to clean the property when leaving. Find more holes in the walls, have to replace more doors, etc. May not be the case in your area but pride of ownership and back end repairs have been cheaper in my experience.
You can make some money here, it is definitely the low hanging fruit in real estate. If you can do this without any time involvement great but just being the owner of a property is going to take some time. Sure, we would all chase a cash on cash return of 30% but how much time would you spend chasing it if you can only invest $10k? And how much time would you spend if you know you lost most liquidity?
This may be the only way for people to invest if they have a poor DTI ratio or no income on their own.
I would agree... that tenants on assistance, typically have their security deposit paid for. This was a case with a prior tenant we had, and when her lease was up, we made the business decision to not renew her lease, because she was a pain every month to collect the rent from. Damaged the property, and the day that her lease was up, she left a behind a pill of old TVs and personal items which filled the two car garage of this property. Which we had to hold for 21 days before getting reed of. It took us that long to bring the property back to good condition. She didn't care about the deposit was it wasn't her money to start with.
With that said... the current tenant we have in this same property is getting assistance from a local church. But in this case, we required the equivalence to two months worth of rent for the security deposit, plus the first months rent. Plus in our vetting process, we learned that this church does reward the tenant, by allowing them to keep the security deposit. This tenant has been get tenant at this point.
@Joshua Hollandsworth If he has some secret formula that works I would love to hear it and I'm sure the rest of the world would too. I have been in this business for several years, have done hundreds of deals and have never seen it work. Let's be realistic, if it was that easy, everyone would be doing it. Everyone isn't doing it because since the housing crisis of 2008, the investment markets are littered with those that tried it and got wiped out. This isn't some new idea that your friend just discovered. First of all, you can't rehab a house for $7500. That is barely lipstick on a pig. These properties are almost always in bad condition and need extensive rehab just to make them habitable. The other thing that you're missing the mark on entirely is turn over costs. Vacancy costs are not just the lost rental income. These properties are notorious for huge amounts of damage and expense just to get them rent ready again It's not unusual to have copper wiring and pipes stripped and AC's stolen. The walls and floors are so trashed they need to be painted and replaced with every turn over which is often more than annually. Your turn over costs far outstrip your cash flow. I don't know the Cleveland market but there is nothing to make me believe that the tenants for these kinds of properties are going to be any different there than they are in Indianapolis and Kansas City which I do know well. The bottom line is that you can't get good tenants to live in bad areas.
Dealing with 10k houses that need extensive rehabs (b/c they will) is going to present many challenges. I also agree with some of the above statements about tenants. It is VERY difficult to find a tenant that you won't have rent collection issues with or property damage.
For houses with those price points, my worry would be what kind of tenant you're going to get, as well as of course, the area. Turnover from tenant to tenant will be consistent, and getting tenants to pay for a B/C class rental is hard enough, but will likely be even harder in those low income areas. We've bought a couple houses for lower price points, but those deals were fairly exceptional, as they were located very well, and weren't what I would call low income areas. We wouldn't have touched them otherwise. I bought a property in August for $19k, and we put about $22k into it, and it rents for $650, could probably rent for $700-725. Renting it out will never be a problem because of where it's located. We have several people who live on that block who have been waiting for an investor to fix it up, and when we have any vacancy there, we have a wait list.
We've looked at tons of houses like the ones it looks like you're looking at. My worry would be class of tenant, but also the safety of the property when it goes through spells of vacancy, whether it be stolen mechanicals, stripped flooring, or exterior damage. Not to mention likelihood of depreciation. You can make some money doing that, as the numbers certainly sound good, but rentals get tricky, especially in low-income areas. Also as John mentioned, you're going to have a hard time selling it if it comes to that, and finding someone good to manage it.
This is a model that can work, but I don't see how its sustainable with a hands off approach. As others have pointed out, all it takes is one of the houses to get trashed to completely destroy your return. Google Mike McLean Section 8 Bible. A great compilation of stories and tips from guys that put together hundreds of Section 8 rentals in Philadelphia and did well....but also self managed and kept tight control of everything going on (including being at the properties a lot) and learned how to deal with the local housing authority themselves. Many PMs do a great job but you shouldn't expect them to spend twice as much time managing your tough property at the standard rate ($75). And saying that you aren't losing anything when the house is vacant during turnover isn't accurate - you don't have your monthly $s for taxes, insurance, PM, reserves + it automatically lowers your return.
some notes about specifically on your description
$282 on a $17,500 investment is a 19% return rather than 25% right? and does the $10k include closing costs on the purchase (another $500-$1000)
a $10k house in Cleveland is in a war zone unless its wrecked. In which case you can't bring it up to Section 8 approval level for $7500
my experience dealing with CMHA (Cleveland housing authority that manages section 8) was that it was hit or miss in terms of both the rental rate you'd get and inspections. Its ideal to have rent $ direct deposited every month and there's a giant waiting list but everyone should understand that along with this you lose some control over the rent you get and the required repairs which obviously affects your return
Section 8 tenants want to live in good areas just like everyone else. Because of the lack of supply, they may settle for less than desirable areas but the good ones will always be looking for a B or C area house to move to. (= high turnover)
if your friends have never been to the property, they aren't aware of possible safety issues. Contractors are only going to fix what you tell them to. Even a complaint to Section 8 (valid or not) can disrupt your cash flow for months. An accident due to a defect in the property could be a disaster.
This is just one of many approaches to investing in real estate. Like any other approach, you really need to dig into the numbers and look at long term results. The key is not finding the one overall best approach- but rather the one that works for you personally and is sustainable. If you don't have a lot of $ to work with, have good street sense and an understanding of the tough areas - this may work well. If you have to depend on others to manage this type of investment for you, it could turn into a disaster. What worries me about your friend's approach is not the area, low $ investment but rather the hands off, never seen the property approach. Hopefully it continues to work out OK for them.
Its a great strategy as affordable housing is needed everywhere. Its lots of negative stereotypes about lower income areas and its a huge disservice to people in general to broadly and negatively paint an entire community. That being said, screening is essential in all rentals. Therefore, have an intact screening process that allows one to get good tenants. Most areas have housing educational classes for homebuyers who want to purchase in the next 3 to 5 years.These are great places to look for tenants or advertise one's housing stock. Also, most people dont want to lose their section 8 vouchers as its a long wait to get approved. Most of the time when I see bad housing in low income areas, the problem is with the absentee landlord who lives 20 - 50 miles away and is only concerned about a paycheck. Most of the time, the landlord dont provide the same maintenance as if the house was located in a more affluent area. Emergency repairs in low income areas don't give the same attention from slumlords. Whereas affluent area rentals maintenance issues are addressed "Johnny on the spot!".. So, if a person screens properly, provide a decent clean rehab, don't look at and treat the tenants like they're animals, provide proper maintenance, and visit their property periodically, then its a win. You may have slightly more evictions, but if you're providing quality housing, the best tenants will seek you out...
Less competition means greater opportunities for people with less capital and more choices in deploying capital in that market.
Not all section 8 tenants have 100% of their rent paid. We have had a tenant who had to pay $110/mo of their rent.
Section 8 can/will abate rents for various things. Failed inspections. Paperwork problems. They do not pay back rent when it is reinstated. You just get tenants who reside in your home for free.
Tenants can get kicked off of the program by the inspector. A couple of years ago, we had an inspector from IHA come in and give us a list of 4-5 items that needed addressed. We addressed these items and thought that was it. What we didn't know is that he gave the tenants 2 items that needed addressed as well. They were supposed to change a light bulb and the battery in the thermostat. Neither were done when the inspector came back and the tenant was kicked off of the program. Worse yet, there was no income and the tenants weren't moving or paying rent. We had to evict them. Fortunately the tenants did leave the home in fair shape.
None of these things really matter to me though. I don't mess with section 8 because there is no IRR. The assets simply do not appreciate. Let's look at it this way...
I purchase a $115,000 home for $90,000 that needs about $2,000 in work. I pay about $20,000 down for financing. The home rents for $1,200/mo and I net about $2,500/year after financing. Sure that's 12.5% ROI. Above average. Now this 10 year old vinyl village in a B neighborhood is appreciating 3.5% each year. That is over $3,500/year in appreciation and it's actually growing every year. I believe @Mike D'Arrigo quoted on another thread that many of their properties have been appreciating for over 6% for several years. So now my $2,500/year in cash flow plus $3,500/year in appreciation makes $6000+/year on a $20k out of pocket investment. Now of course you actually don't see this until you sell the property, but that is a 30% IRR.
Now take a section 8 property. All-in cash purchase and rehab of $20k and renting for $800/mo. Applying the 50% rule, which in my experience is consistently close, your looking at $4,800/year of net income or 24% ROI. The issue is... appreciation is going to be relatively non-existent. Partially because of the area and the desirability of the area, but also because of the value of the asset. If the home ARV/FMV of the rehabbed home is $30k and it appreciates 3% (not too likely though) you are looking at an extra $900/year in growth. That ends up being a 28.5% IRR. So why would I consider a less valuable asset class that caters to higher risk clientele for a lower IRR? Too many people just look at cash flow. Maybe I am at an age where I am not concerned about cash flow yet as I love my day job and it pays my bills, but I do look at ROI as I am building up my assets to have enough cash flow when I decide to quit working.
At the end of the day, it really comes down to resources, goals, expertise, and risk tolerance. If you just want to look at cash flow, it may be a viable option, but I don't like the risk that comes along with it. Many people who started with section 8 are no longer with the program. The reason is that the speed bumps that come along with it can be too costly. If you invest long enough, in any asset class, you will hit a speed bump. People will always divorce, die, get laid off, have addiction problems, engage in criminal activity, or any number of things that can interrupt the performance of your investment property. They don't even have to be high risk/bad tenants... just normal ones overwhelmed with a stressful circumstance.
I always recommend going the route where liabilities are easiest to control. Personally, I consider making yourself subject to the whims of government and government programs a liability. I keep paying FICA but I don't expect to see the benefits of social security. I pay taxes that get spent without accountability. Why would I trust the government to guarantee payments for a low-income tenant? I'd rather give a low-income person an education and a job than a free place to live.
I am seeing a lot of negative feedback. As usual. Lol. This is not a business model that I have pursued, so I don't understand how it works. Just testing the waters. I purchase rentals in the 50k-70k range. Often turnkey, with less than 5k required to repair the property. I don't see how you guys will purchase 100k+ houses and make a couple hundred bucks a month, but someone buys a 35k house, cash flows $400/Mo. And they're an idiot? Who is REALLY going to hurt if the economy crashes? The landlord who owns a 150k SFR and pays $6000/ year for taxes and insurance, or a landlord who owns a 35k duplex and pays $2000/yr for taxes and insurance, (and no matter the state of the economy, low income housing will always be needed)?
Basically, it appears to be a matter of preference, and whether one wants to be a cash flow investor or an appreciation based investor. Each require a different skill set, and risk tolerance. In my opinion, both will work if done correctly...
Not factoring in the difficulty & frequency of actually collecting income on a $15k house can be career suicide. On top of that the turnovers are almost always more expensive. In my experience you are usually not getting rents high enough to cover taxes, insurance, water, sewer & the annualized costs of turnovers.
The one guy I know who actually kills it in this market is an eviction mover by trade. He also has a very checkered past, with several stints in jail.
Ya see the thing with him is he is very "hands on." As in he carries a side arm at all times to collect rent in person. I've heard stories of tenants who stopped paying having their front doors being removed as well as rats being let loose in their homes.
In my opinion all of that is nothing I'd want to deal with. From a moral, ethical, financial, legal & saftey standpoint. Its all horrible.
I think that difference is that @James Wise, myself, and probably some others in this thread manage hundreds of properties for ourselves and other parties. These properties range from good to bad and maybe even worse. After you've seen homes that need $7,500+ in repairs almost every vacancy and the fact that they are the types of tenants that you can never recoup the money from, you realize that I will take less cash flow to almost guarantee a profitable performance as opposed to more cash flow that gets wiped out every year or two because of what a tenant has done to the home... or just simply issues because of the age of the home.
If you cash flow $500/mo that is $6,000/year. If you spend $8,000 every two years and lose 2 months rent and have holding costs of $200/mo during those months you are losing $9,400 of the $12,000 cash flow. Now we are down to $2,600 for 2 years. That's no better than the $200/mo made on the $100k house, just a lot more more headaches. Personally, I don't like to stress... so I prefer to invest in better assets.
It's no different than the person who pays $2,500 cash for the 20 year old car that get 18 miles to the gallon and needs repairs twice per year or the person who pays $400/mo for a new car that gets double the gas mileage and doesn't need anything other than scheduled maintenance. At the end of the day, either one works, it's just about the experience of owning that particular asset.