What they don't tell you about cheap rental properties

[Marcus Auerbach]

It all sounds so perfect: you can buy a house for cheap, have someone else fix it up for you and then rent it out for great cash flow. You run the numbers (on a BP calculator, they are really good BTW), you read the forums on BP and after moneth of research you are convinced this will work!You can make it work!

So you narrow it down to a city (maybe Milwaukee) and you call an "investor friendly agent" to help you find a great inexpensive property. There are some on Zillow for 5k, so spending 50k or 100k will surely get you a good deal. And you won't have to deal with the tenants, because you will have a PM to do that for you, so problem solved (in theory at least). Some agents tell you that's a bad idea, they probably were not the investor friendly kind, plus most agents don't understand investing (which is true), so you just keep looking until you find one who is happy to write a few low ball offers on cheap properties - and you buy your first one!

Surprise number one is finding contractors is a lotharder than they made it sound in the book! Let alone getting three bids! Contractors are either booked out for the year, or they are expensive, or the worst, not trust worthy. Finally you found one, but when you tell him where the property is, he does not want the job anymore. He is worried about his truck and his tools, not worth it he says.

I have seen a lot of houses over the years that have been "remodeled" remotely and I have seen the "quality" of work that can come without the owner checking in person. Like upper cabinets "secured" by finish nailes, makshift plumbing and electrical, trim and woodwork that looks like a kindergardener has installed it, drywall that shows every single seam, roofs that leak from day one. The best part, it is almost impossible to sell a house like this, even a low income buyer will get scared by the home inspector.

The remodel went over budget, but after 7 months of remodel agony now its time for cash flow and to hire a PM to get the place rented. Turns out not every PM wants to take on your property when you tell them the address. But you finally find one who will do it and has a low enough fee. So you hire them and they place a tenant. Rent starts comming in - finally success!!

So you go ahead and buy a few more of these properties. It is hard work, but you have mastered the first one, you have learned a few things, the next one will go better.

A few years into this and with a hand full of cashflowing properties you start to notice that repairs request start increasing. A new furnace, a ton of plumbing repairs on the 60 year old galvanzed pipes, the PM says they need to fix the ceiling, because the roof (that had a few years left when you bought it) is leaking. You realize that capex is exceeding cash flow.

Meanwhile there are some problems with the tenants. You receive fines from the city (DNS) for littering and trash, the police gets called to deal with issues, one tenant moves out, and the PM can't seem to get a grip on this. No rent for 3 months. You had enough and fire your PM, find a new one. The new guys come with a hole list of expensive repair requests, 15k in total, but they also recommend a few extra things on top of that like a new garage. You decide to make a trip and find the place is trashed. You have never seen anyone living in such a flith. The weeds grow tall, fast food wrappers everywhere. The aluminum siding has dents everyhwere!? Walls are damaged and dirty, someone punched a hole in a beedroom door. There are drawers missing from the kitchen cabinets....!? 

Now you have to deal with an eviction, you try to get money from the tenant for damages. Attorney, small claims court, daily emails and phone calls. Tenant has no money, just fieled for bankrupsy. Meanwhile you are trying to find a contractor, who can get the place ready and an agent to sell it. An investor offers you half of what you paid. You finally get it listed, an offer accepted, home inspection comes back and reviels a whole list of expensive repairs. The elctric panel is not safe and needs to be replaced, a basement wall has a crack and needs to be beamed, probably cause by water from the missing  downspout extensions. Reluctantly you agree to get all these repairs done, more working with contractors, more expenses. But it will soon be over!

A week before closing you get a phone call from your agent. Financing fell apart, because the buyer has lost their job. So back on the market, you just paid the foundation contractor and the electrician an amount that equals about 20% of the list price.

You can see where this is going. I am currently working with a friend of a friend helping him liquidate his small portfolio. I have done this before, it's often more work and frustration to sell a cheap house than one for 200k or 300k (or 600k). He basically went through the experience above, he said he never should have, it was a bad idea. I am not excided about the listings, I can barly cover team expenses, I do it just to help him out.

Last night someone called me, saw me on BP,  is looking to buy investment properties, no experience and never been to Milwaukee, but he heard it's great. Wants to buy two houses every year until he has enough cash flow to retire, hates his job. Tells me the hole plan. Budget is 80k per house. I explain that I have been a buy and hold investor for over a decade, done a lot of BRRRs, worked with a lot of investors. Median home price in Milwaukee is now over 200k, he'll be in a rough neighborhood. That I am personally buying only properties that are at least twice that amount, that's before rehab. It's 2021, prices are up, market is hyper competitive. I am telling him why this is a bad idea. 

He thanks me for my time and asks me if I knew of any more investor friendly agents.... 

True story, food for though.

[Jay Hinrichs]

Originally posted by @John Teachout:

I think that many of the properties that eat OOS investors could cash flow nicely if they were local to the landlord. The greener grass that many seek often turns into the mess described in the post. I think the issue is more the OOS investment model than the actual class of properties. Many of these low cost properties need the oversight of a hands on investor that can do the repairs, manage the properties themselves and are in close enough proximity that they can be inspected and maintained on some type of schedule. We live off of rental income but it's anything but "passive" for us.

Exactly its a job you change one for the other one you work for someone and like so many state on here they hate it.. flip side is your self employed and you work for yourself.. many love that.. but just sit back and let D class rentals create cash flow from the work of others adn you retire you either need a boat load of them or you need Zero debt .. its kind of like flying little airplane safely ..  Terrain  Night  IMC  ICE  Pick ONE  so with these assets you can have all the comibnations of  PM  not local  unstable tenant base etc and max debt.. PICK ONE>

[Derric Johnson]

@Marcus Auerbach thank you. I am a new investor and actually want to invest in Milwaukee. What you just explained was my first thought. Now after more research and hearing this exact same thing from a few others I am not going for the super cheap. I am also going to start coming to the meet ups and learn way more about the area

[Jaquetta T Ragland]

@Marcus Auerbach sounds like a potential ebook to me...because you are telling nothing but the truth.

[John Teachout]

Originally posted by @Jay Hinrichs:

Exactly its a job you change one for the other one you work for someone and like so many state on here they hate it.. flip side is your self employed and you work for yourself.. many love that.. but just sit back and let D class rentals create cash flow from the work of others adn you retire you either need a boat load of them or you need Zero debt .. its kind of like flying little airplane safely ..  Terrain  Night  IMC  ICE  Pick ONE  so with these assets you can have all the comibnations of  PM  not local  unstable tenant base etc and max debt.. PICK ONE>

 Flying planes in all of those conditions (many on the same flight) is what I stopped prior to becoming  a full time real estate investor. Yeah, for us it's a job.

[Jay Hinrichs]

Originally posted by @John Teachout:

Originally posted by @Jay Hinrichs:

Exactly its a job you change one for the other one you work for someone and like so many state on here they hate it.. flip side is your self employed and you work for yourself.. many love that.. but just sit back and let D class rentals create cash flow from the work of others adn you retire you either need a boat load of them or you need Zero debt .. its kind of like flying little airplane safely ..  Terrain  Night  IMC  ICE  Pick ONE  so with these assets you can have all the comibnations of  PM  not local  unstable tenant base etc and max debt.. PICK ONE>

 Flying planes in all of those conditions (many on the same flight) is what I stopped prior to becoming  a full time real estate investor. Yeah, for us it's a job.

YUP only the pro's do all of them at once.. I have done it a few times in the northwest landed and said WTF  why did I do that. 

same with ghetto dogs  why did i think I could make it work 

[Darius Ogloza]

Basic economics + common sense.  Markets are pretty good at pricing assets but not perfect.  99 out of 100 times a $5,000 house will be worth exactly that - $5,0000 (or usually less because of the property tax burden).  However, sometimes anomalies exist and opportunities for arbitrage arise.  Hence, the dream factories.  But here is where common sense comes into play: why would any local who comes across such a rare jewel in Elkhart Indiana or Bryan Ohio hand it over to some newbie/stranger/douchebag from LA or NYC of SF?  Not gonna happen 99 out of 100 times.     

[David Terbeek]

This couldn't be more true.  When we started managing in Cleveland we picked up a lot of doors in the city.  Myself and my first hire were well versed in the neighborhoods and they were easy to get - rapid door growth.  After 3 years we were picking up doors but revenue was lagging and net income was flat not to mention the owners were high touch because the properties were even more time intensive.  We cut nearly 20% of the doors (one large group of investors) and limited acquisition of low rent units.  It was magic:  doors went up, revenue went up, profit went up - litterally skyrocketed that year.  Oh, and our clients were all a lot happier so they referred their colleagues, staff was happier, etc.
I do know a few local investors that work in the city happily and profitably on their own portfolios but it is an art that is difficult to reproduce if you are buying from a distance.

[Jack Hendrickson]

@Luciano A. Just a question, I was looking at a duplex that was built in 1900 but it is in a good area and very kid friendly, there is repairs that need done but I don’t want to buy it and end up like this story right here!?!? So basically my question is, is it to old to buy it, being it’s built in the 1900 and I am gettin it for150,000, thank you so much

[Shiva Bhaskar]

Originally posted by @Marcus Auerbach:

It all sounds so perfect: you can buy a house for cheap, have someone else fix it up for you and then rent it out for great cash flow. You run the numbers (on a BP calculator, they are really good BTW), you read the forums on BP and after moneth of research you are convinced this will work!You can make it work!

So you narrow it down to a city (maybe Milwaukee) and you call an "investor friendly agent" to help you find a great inexpensive property. There are some on Zillow for 5k, so spending 50k or 100k will surely get you a good deal. And you won't have to deal with the tenants, because you will have a PM to do that for you, so problem solved (in theory at least). Some agents tell you that's a bad idea, they probably were not the investor friendly kind, plus most agents don't understand investing (which is true), so you just keep looking until you find one who is happy to write a few low ball offers on cheap properties - and you buy your first one!

Surprise number one is finding contractors is a lotharder than they made it sound in the book! Let alone getting three bids! Contractors are either booked out for the year, or they are expensive, or the worst, not trust worthy. Finally you found one, but when you tell him where the property is, he does not want the job anymore. He is worried about his truck and his tools, not worth it he says.

I have seen a lot of houses over the years that have been "remodeled" remotely and I have seen the "quality" of work that can come without the owner checking in person. Like upper cabinets "secured" by finish nailes, makshift plumbing and electrical, trim and woodwork that looks like a kindergardener has installed it, drywall that shows every single seam, roofs that leak from day one. The best part, it is almost impossible to sell a house like this, even a low income buyer will get scared by the home inspector.

The remodel went over budget, but after 7 months of remodel agony now its time for cash flow and to hire a PM to get the place rented. Turns out not every PM wants to take on your property when you tell them the address. But you finally find one who will do it and has a low enough fee. So you hire them and they place a tenant. Rent starts comming in - finally success!!

So you go ahead and buy a few more of these properties. It is hard work, but you have mastered the first one, you have learned a few things, the next one will go better.

A few years into this and with a hand full of cashflowing properties you start to notice that repairs request start increasing. A new furnace, a ton of plumbing repairs on the 60 year old galvanzed pipes, the PM says they need to fix the ceiling, because the roof (that had a few years left when you bought it) is leaking. You realize that capex is exceeding cash flow.

Meanwhile there are some problems with the tenants. You receive fines from the city (DNS) for littering and trash, the police gets called to deal with issues, one tenant moves out, and the PM can't seem to get a grip on this. No rent for 3 months. You had enough and fire your PM, find a new one. The new guys come with a hole list of expensive repair requests, 15k in total, but they also recommend a few extra things on top of that like a new garage. You decide to make a trip and find the place is trashed. You have never seen anyone living in such a flith. The weeds grow tall, fast food wrappers everywhere. The aluminum siding has dents everyhwere!? Walls are damaged and dirty, someone punched a hole in a beedroom door. There are drawers missing from the kitchen cabinets....!? 

Now you have to deal with an eviction, you try to get money from the tenant for damages. Attorney, small claims court, daily emails and phone calls. Tenant has no money, just fieled for bankrupsy. Meanwhile you are trying to find a contractor, who can get the place ready and an agent to sell it. An investor offers you half of what you paid. You finally get it listed, an offer accepted, home inspection comes back and reviels a whole list of expensive repairs. The elctric panel is not safe and needs to be replaced, a basement wall has a crack and needs to be beamed, probably cause by water from the missing  downspout extensions. Reluctantly you agree to get all these repairs done, more working with contractors, more expenses. But it will soon be over!

A week before closing you get a phone call from your agent. Financing fell apart, because the buyer has lost their job. So back on the market, you just paid the foundation contractor and the electrician an amount that equals about 20% of the list price.

You can see where this is going. I am currently working with a friend of a friend helping him liquidate his small portfolio. I have done this before, it's often more work and frustration to sell a cheap house than one for 200k or 300k (or 600k). He basically went through the experience above, he said he never should have, it was a bad idea. I am not excided about the listings, I can barly cover team expenses, I do it just to help him out.

Last night someone called me, saw me on BP,  is looking to buy investment properties, no experience and never been to Milwaukee, but he heard it's great. Wants to buy two houses every year until he has enough cash flow to retire, hates his job. Tells me the hole plan. Budget is 80k per house. I explain that I have been a buy and hold investor for over a decade, done a lot of BRRRs, worked with a lot of investors. Median home price in Milwaukee is now over 200k, he'll be in a rough neighborhood. That I am personally buying only properties that are at least twice that amount, that's before rehab. It's 2021, prices are up, market is hyper competitive. I am telling him why this is a bad idea. 

He thanks me for my time and asks me if I knew of any more investor friendly agents.... 

True story, food for though.

 Great post Marcus! I am in Los Angeles and invest locally. We looked at properties in a Midwest city very similar to yours, went out there for 4 days and met lots of folks etc. It was a wonderful experience traveling there, but I know multiple folks who invested there and had very serious issues. Some did succeed, for sure, but the things you mentioned end up eating the investment. 

The funny thing is, while I was there, I met a local investor who owned properties in the rougher areas. Very hands on guy. He did incredibly well because he knew how to manage tenants and situations. We have a few properties in LA that are in challenging areas, but being local, buying right, does help. I really like your model though. I think it's the closest you can find to a sure thing in real estate. 

[Luciano A.]

@Jack Hendrickson

This is a loaded question because there are many factors on whether to buy or not. If the area is all composed of 1900 builds and others are buying and not tearing down then it's possible to find a good buy. If you have the only 1900 home in the area then it can get costly. But again if the area is predominately the same age then you shouldn't have issues finding trades that are familiar with the age of a property. However, as in any rehab what you see might not be what you get once you open up walls. If you are going to rehab the city will require you to bring things up to code and that is when it can get very expensive. For example, if you remove say the plaster walls and want to put sheetrock the city might have you insulate all the exterior walls. Even if you open one wall. This is something to consider. Each City operates differently as does each inspector and how they are feeling that day. If this is your first buy I would advise you to drive around find other similar properties being rehabbed and talk to the GC or owner and ask them about their experience and any pitfalls on that project. Ask what did they find that was unexpected and if any item was a budget buster. I think older homes were built like tanks unlike homes today. Back then a 2x4 was a real 2x4 lol. But who owned it and their upkeep is also important. 

Best of luck 

[Jack Hendrickson]

@Luciano A. thank you so much for this help, it’s much appreciated 

[Curt Smith]

@Marcus Auerbach I'm just wanting to help folks with a business model for buying good rentals that avoid the problems that you described.

Go check the file I've linked off my bigger pockets profile 1st paragraph, how to buy a bulletproof rental portfolio.

It focuses on the tenant 1st then buy the house to match the tenants needs.

It's a great story I'm sorry to hear it but I could have guessed the outcome from my own experience I hope folks listen.

[Jim K.]

I think there's a good part of "The Book on Investment Properties to Avoid" in this thread.

[Nick Dunin]

@Marcus Auerbach

Great advice! Thank you

[Leonard Brown]

@Marcus Auerbach great post! I’m dealing with an OOS investor now. New to my market and stubborn on his process. A lot of newbies are fixated on the ideal situations we’re all accustomed to hearing on the videos and podcasts from seasoned investors. The most problematic thing I’m seeing is they are buying a property just because it’s a deal with no knowledge of the local market, a pre-planned rehab budget (not actually associated with the property in question), and the expectation of a stellar return. That’s simply not how real estate works.

[Dawn Anastasi]

It's not so much about the age of the property but the location and the condition of the property. There are many people that LOVE living in properties built in the late 1800s and early 1900s because of the craftsmanship and details in woodwork, etc. But guess what, those houses have all new electrical, newer plumbing, a solid roof, etc. They are in a good location and have people who care for them. Those houses might sell for 150-200k.

Then on the opposite spectrum you might have a $5,000 house that needs $100,000 worth of work to get it livable but at the end, will only be worth $60,000 due to the location.

Someone local will know that. 

Partnering with someone local is the way to go. But this is difficult to do. Why should a local partner with someone they don't know who's not even going to help them get anything done and might split after a few years? The person who's local would need to be compensated more to account for this.

[Arya S.]

@Marcus Auerbach

Exactly my experience when I tried doing this in Detroit back in 2009-2012. Exactly. Bought 22 SFRs within a few months and the repairs/evictions stated almost immediately.

Several PMs later…. Luckily I was able to sell it all and start investing locally in the Bay Area for $200-300K/door. Much better tenants, they actually pay!

Excellent post.

[Jeff S.]

@Jack Hendrickson the important thing you mentioned is the area. I own a 1910 duplex that is awesome. Have owned it since 1991 and have almost no upkeep. I did a complete roof tear off on its 100th birthday. It had its original roof that probably lasted 40 years and 2 on top each probably there for 30 years each. Paid $52,500 and now worth easily $525,000.

Most of the valuable areas in Portland were built in the 20's with some Victorians built in the 1800's. Just beware of the city eyeballing asbestos and lead paint. Good to have a solid credit line.

[Karl B.]

This is precisely why I self-manage (despite being out of state). 

[Jeff S.]

@Jack Hendrickson the important thing you mentioned is the area. I own a 1910 duplex that is awesome. Have owned it since 1991 and have almost no upkeep. I did a complete roof tear off on its 100th birthday. It had its original roof that probably lasted 40 years and 2 on top each probably there for 30 years each. Paid $52,500 and now worth easily $525,000.

Most of the valuable areas in Portland were built in the 20's with some Victorians built in the 1800's. Just beware of the city eyeballing asbestos and lead paint. Good to have a solid credit line.

[Jason Moomaw]

@Marcus Auerbach

Wow, this is rough, is there anything you wished you would have done differntly on this one?

[Tim Ryan]

@Marcus Auerbach Oh my, that’s a long post to say “this is not an easy business”. Very true. It’s a business when doing the deal like you did -

Not a passive activity. Hard way to figure this out for sure. I’m with you in that people love to make it sound easy.

My favorite is this:

“I’ll wholesale several deals this quarter, then take those funds and flip a house, then take those 6 figure funds and buy an apt, then retire young and rich”

Truth is, it’s hard work whatever you do unless you are truly passive and invest with someone who does all the hard work (still hard work in the deals).

Funny you mention Milwaukee because I’m actually doing extremely well in that area over the past 3 years and I live in Los Angeles.

[Eric James]

Originally posted by @Leonard Brown:

@Marcus Auerbach great post! I’m dealing with an OOS investor now. New to my market and stubborn on his process. A lot of newbies are fixated on the ideal situations we’re all accustomed to hearing on the videos and podcasts from seasoned investors. The most problematic thing I’m seeing is they are buying a property just because it’s a deal with no knowledge of the local market, a pre-planned rehab budget (not actually associated with the property in question), and the expectation of a stellar return. That’s simply not how real estate works.

 Of course they're stubborn. They know what they're doing..... because they've read a book that tells them what they want to hear. lol

[Drew Sygit]

Just to build on what you wrote, many OOS investors don't truly take the time to understand:

1) The Class of the NEIGHBORHOOD they are buying in - which is relative to the overall area.

2) The Class of the PROPERTY they are buying - which is relative to the overall area.

3) The Class of the TENANT POOL the Neighborhood & Property will attract - which is relative to the overall area.

4) The Class of the CONTRACTORS that will work on their Property, given the Neighborhood location - which is relative to the overall area.

5) The Class of the PROPERTY MANAGEMENT COMPANIES (PMC) that will manage their Property, given the Neighborhood location and the Tenants it will attract - which is relative to the overall area.

6) That all of these Classes are usually vastly different than the local market they live in.

7) That a Class X NEIGHBORHOOD will have mostly Class X PROPERTIES, which will only attract Class X TENANTS, CONTRACTORS AND PMCs and deliver Class X RESULTS.

8) Class A is relatively easy to manage

9) Class B usually also okay, but needs more attention from owner and/or PMC

10) Class C can be relatively successful with enough attention from owner and/or PMC (do NOT hire the cheapest!)

11) Class D pretty much requires an OWNER to be hands on. A PMC should not try to manage as they will have to charge too much to make it worth their resource investment. 
***Only exception is if an owner has plan & funds to reposition Class D to Class C or higher.

[Vlad B.]

@Marcus Auerbach Great post! Hopefully, the person that has this investment has great mentors or BP to help them out of the situation. Early in my RE journey I almost purchased such a property being from OOS. I was saved by my inspector who provided me the truth about the area and woke me up from my stubbornness. 

Since I have developed two rules that have helped me stay away from "cheap" housing. Rule 1) If I can't find 3 Property Managers that would manage the area, perhaps this isn't a property I can invest in from out of state. Rule 2) If the property is not a safe place to live inside and outside, and the money invested to make it safe and affordable for my tenant isn't possible, then I stay away.