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.

[Jenning Y.]

@Marcus Auerbach   Great post. That's why as a long time OOS investor myself, I mainly invest for appreciation.

 My old post:

As an Out-Of-State Investor for 9 Years… (biggerpockets.com)

[Wesley Whitehead]

Great post Marcus.  I fell into this trap as an OOS on my second rental property and ended up selling it at the beginning of COVID because it simply wasn't worth the trouble of keeping for many of the reasons you listed.

Jay, you also have a great point that living soley on the cashflow of your rentals is not as easy as it sounds.  Having 10-20K a month in cashflow sounds great but all it takes is a couple of large ticket items breaking down and an eviction or 2 and there goes the cashflow.  Many people look at investing as a way to quit their jobs early and this game is a marathon not a sprint.  Yes there are people who have scaled up very quickly but ask I will venture to say that none of them said that it was easy work to scale that quickly.

My lesson is that quality does beat quantity over time.  A good property in a decent neighborhood that cashflows beats cheap properties with ridiculous cashflow.  

[Eury Marte]

@Marcus Auerbach thank you for sharing this info. I am trying to expand my portfolio and am researching the best markets with with cashflow potential. I have a property outside of Boston, MA and it is just too expensive to do anything in that area at the moment. I have been analyzing multiple properties and have read the books. I know what needs to be done, in theory. However, a part of me has this nagging fear of going through the same experience as your friend. Unlike them/the person that called you asking for agents in the area, I am willing to (and rather) pay for a property in a better neighborhood in need of some cosmetic work. I am in the process of networking with agents, PMs, and contractors to have a team in place.

Your post has been a reminder to me that doing the proper checks up front (reaching out to agents, PMs, and even contractors) and listening to the people that live/know the area before jumping on a deal saves a lot of heartache in the future. I’ll look into the Milwaukee market and reach out to you if it seems like something that would fit my criteria.

[Allan Smith]

Most of my 45 rentals are in the hood. While the original post is true, mine have been the exception so far, perhaps due to:

1. many of the neighborhoods are getting better, which changes the whole equation. Better tenants. Appreciation is the biggest factor.
2. I found a dang good property mgr
3. for half of those 45, I am the dang good property mgr ha. I watch expenses like a hawk and I have learned how to work with low income tenants. Gotta be firm, and relentless on the screening. 4 or 5 applications will be rejected before one that works
4. long term tenants have kept my turnover low

[Nate Sanow]

@Marcus Auerbach

Genuinely a fantastic post - unique and well written.

Honest question I didn’t yet see - just for conversation, not debate per se... What about “cheaper” properties in the path of progress? There are so many properties I wish I had bought under $100k even under $50k now worth much more. Certainly would have had headaches but also have increased in some cases as much as 10x.

[Leo Peralta]

@Marcus Auerbach

Great post!

As new real estate investor, I needed to hear this. I’m still doing my homework on how to get started but didn’t come across the possible risks that I need to consider. Just like everyone else’s replies, this is what happens when you got for cheap and great on paper. Quality over quantity. Only reason I’m considering OOS is solely because I live in San Diego, CA where median housing is 500k at the moment. Totally a fan in investing in my backyard if the opportunity presents its self.

[Noah Spiegel]

@Marcus Auerbach thank you so much for this. Actively looking for my first property now but thanks to this I’ll narrow my search. Well worth the read!!!

[Diana Costta]

@David Terbeek Nailed it.

[Jay Hinrichs]

Originally posted by @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.

Dawn long time no see.. welcome back hope your doing well.

[Andy Brown]

@Nathaniel Walker

Exactly. And we should remember the OP was dealing with D class flips on the cheap out of state. Many replies have been decrying OOS as a whole which is too sweeping. I think there are many of us on here doing fine investing out of state and just chuckle with the overbroad statements that you can't make money out of state.

That being said, the OP is still spot on and the savvy OOS investor (or let's be honest, even the savvy local investor) will either avoid those types of properties and flips or do some incredible due diligence to get a stellar team in place--but even then...

The trick to out of state investing is essentially replicating your presence in the area through your agents/team. By having a solid PM and a variety of others who are all driving by the properties on occasion, sending you pics, and allowing you to cross check each member at a certain level, you're able to create a similar accountability as to being local. What a lot of the local investors forget is how much time they waste getting elbows deep in their properties because being local hasn't forced them to establish more efficient systems--some local investors, not all.

But as far as the scenario the OP describes, I know my limits and risk level and would never attempt such an endeavor. For me, I know that I'll need to pay more for something that needs minor renovations in a better part of town, which is one easier way to mitigate a lot of what is being addressed. For that matter, I also know I wouldn't attempt a 5k purchase and rehab in my own town either.

[Dawn Anastasi]

Originally posted by @Jay Hinrichs:

 

I've been around ... just not much going on these past year and more due to Covid.

[Jay Hinrichs]

Originally posted by @Andy Brown:

@Nathaniel Walker

Exactly. And we should remember the OP was dealing with D class flips on the cheap out of state. Many replies have been decrying OOS as a whole which is too sweeping. I think there are many of us on here doing fine investing out of state and just chuckle with the overbroad statements that you can't make money out of state.

That being said, the OP is still spot on and the savvy OOS investor (or let's be honest, even the savvy local investor) will either avoid those types of properties and flips or do some incredible due diligence to get a stellar team in place--but even then...

The trick to out of state investing is essentially replicating your presence in the area through your agents/team. By having a solid PM and a variety of others who are all driving by the properties on occasion, sending you pics, and allowing you to cross check each member at a certain level, you're able to create a similar accountability as to being local. What a lot of the local investors forget is how much time they waste getting elbows deep in their properties because being local hasn't forced them to establish more efficient systems--some local investors, not all.

But as far as the scenario the OP describes, I know my limits and risk level and would never attempt such an endeavor. For me, I know that I'll need to pay more for something that needs minor renovations in a better part of town, which is one easier way to mitigate a lot of what is being addressed. For that matter, I also know I wouldn't attempt a 5k purchase and rehab in my own town either.

for buy and hold especially out of state I have one rule that is think is so simple but so over looked.. buy at the median home price of an SFR ( if thats what your buying ) or as close to it or above it as possible this one simple buy box will preclude a lot of the horror stories.

buying something for 50% or less than median one just needs to put simple logic to it..  those are the worse properties in the worse areas with the most financially unstable folks in America. .

[David Mo]

@Marcus Auerbach I remember when I was planning to buy my first duplex with you and we had this conversation and it still sits with me today...cheap properties are cheap for a reason, and I would not rent anything out that I wouldn't want to live in myself. 

On an unrelated note, your stories are well written and you should share more :) 

[Marcus Auerbach]

Originally posted by @Corey Frank:

@Marcus Auerbach I think this is a great reality check for sure. Brings life to the side of real estate investing that EVERYONE starting out needs to hear. I am a giant newbie. I would very much like to invest out of state as my local market price/rent ratio leaves no room for any cash flow whatsoever AND even though right now the market is hot like everywhere else in the country, this is a big time bust/boom that relies almost solely on energy the energy sector. The reason I have not yet bought anything is stories just like this one. I 1000% know that no matter how much information I have learned, what I still do not know could possibly ruin me. As much as I would love to relocate to a different market and invest there, it is not possible as my only job opportunity at the moment is where I currently live. What would you recommend someone in my position to do? Keep the analyzing game going, save and eventually relocate? My biggest issue with that is I do not want liquid cash with inflation pretending to be a hot air balloon. 

I don't know at what point I realized that you don't need to know very much to be successful as a buy and hold investor. Rent needs to higher than PITI plus some buffer for repairs. That's pretty much it. And the stuff you don't know you will figure out, ask someone or learn when you need it. It won't kill you as long as you follow what I stated before. The whole business model of buy and hold is actually very forgiving, it's almost impossible to really screw it up. You can do better yes, but killing you? Unlikely.

You should live where you want, Wyoming is one of my favorite states. Start a business, a coffee shop, a tutoring service for kids etc.. But if you want to move, just do it, you will find a job anywhere. we call those "limiting belives" - something that you believe and limits you but is actually not really true.

[Marcus Auerbach]

Originally posted by @Allan Smith:

Most of my 45 rentals are in the hood. While the original post is true, mine have been the exception so far, perhaps due to:

1. many of the neighborhoods are getting better, which changes the whole equation. Better tenants. Appreciation is the biggest factor.
2. I found a dang good property mgr
3. for half of those 45, I am the dang good property mgr ha. I watch expenses like a hawk and I have learned how to work with low income tenants. Gotta be firm, and relentless on the screening. 4 or 5 applications will be rejected before one that works
4. long term tenants have kept my turnover low

 It depends what you call hood! We have different grades of hood. And the fact that you do your own PM is key - if you have the right tenants, the right contractors, it is possible to make it work. The cool think is that you invest a combination of time, money and energy and you can exchange one for another - so in your case more time and energy, but less money. That works. And when you do it hands on than you know what makes the difference. I have staff for my PM, but I am still the person who does that last interview and final approval on a new tenant - they are the real asset! Congratulations on your success!!

[Jeff S.]

In Portland that would be 540k @Jay Hinrichs. Hold 30 years maybe 5 million or maybe 500k? There has to be risk to get reward. Worst case it is paid off worth something.

[Jay Hinrichs]

Originally posted by @Jeff S.:

In Portland that would be 540k @Jay Hinrichs. Hold 30 years maybe 5 million or maybe 500k? There has to be risk to get reward. Worst case it is paid off worth something.

My median price rule is for the mid west cash flow markets..  Portland has no hoods to speak of there are not blocks of boarded up homes and or homes that sell for less than a used Yugo  LOL..  

[Jeff S.]

Just bought a unit in Butternut from 1031 funds, 3 bed 2.5 bath built 11/20 $10,200 upgrades, townhouse end unit 3 plex. A bit of a change from inner Portland. Going from a 1909 built to a 2020 built is interesting to say the least. Might not have been the best deal in the world but ran out of time @Jay Hinrichs.

[Jay Hinrichs]

Originally posted by @Jeff S.:

Just bought a unit in Butternut from 1031 funds, 3 bed 2.5 bath built 11/20 $10,200 upgrades, townhouse end unit 3 plex. A bit of a change from inner Portland. Going from a 1909 built to a 2020 built is interesting to say the least. Might not have been the best deal in the world but ran out of time @Jay Hinrichs.

whats a "Butternut" ?   

this is why I personally am bullish on Vegas.. at least the newer areas of Summerlin or Henderson.. homes that were built in the 90s or 2000s  Stucco  tile roofs desert landscape.. with A class tenants  no income tax and  property tax's subsidized by gambling. property tax's are by far teh lowest I have ever seen in the US for investors.. And say to the tune of 1/3 or so..  so even on the face of these deals that dont hit the one percent rule.. by the time you factor in very low maintenance  no real tenant issues easy eviction laws ( which you generally never have in this asset class) along with some nice appreciation  its a nice alternative to Oregon or other markets that are cheaper.. 

[Jeff S.]

I like Henderson @Jay Hinrichs and scoured Vegas last recession. Launa has a cousin that has an amazing place in the Old Sun City development whatever it is called now. I am trying to simplify my estate. Butternut is the only place I could find that didn’t have bidding wars that is close to my home. The seller increased the price 75k since they closed in December and I happily paid it to find something that could be identified in time. My deadline was yesterday. At Cornelius Pass and TV highway is a huge development. Butternut is 800 units that will connect with Reedsville Crossing.

[Jay Hinrichs]

Originally posted by @Jeff S.:

I like Henderson @Jay Hinrichs and scoured Vegas last recession. Launa has a cousin that has an amazing place in the Old Sun City development whatever it is called now. I am trying to simplify my estate. Butternut is the only place I could find that didn’t have bidding wars that is close to my home. The seller increased the price 75k since they closed in December and I happily paid it to find something that could be identified in time. My deadline was yesterday. At Cornelius Pass and TV highway is a huge development. Butternut is 800 units that will connect with Reedsville Crossing.

OK part of what they called the Sisters property then..  gotcha..  

[Jeff S.]

Just entertainment @Jay Hinrichs. Would have been better off in Candy but just trying to give a friend a deal. She does IT people so they are buying up there. 2 years then move on according to 1031 IR risks. Had to park somewhere. Have 2 other old PDX properties to deal with in future.

[Amy Raye Rogers]

The more active control you take over all aspects of your RE investments, the more value you will be able to extract from your properties, at least in the early days.  Once you have a firm grasp of each component of the business, you can train others to do those functions or you'll be in a better position to vet good teammates.  Taking shortcuts or leaving it to others to "figure it out" usually leads to undesirable results.

[Demetrius Lindsey]

I can say that @Marcus Auerbach has indirectly helped me not purchase in some of those war zone neighborhoods. I bought my first property in Milwaukee 4 months ago. I am so happy that I went for higher end and bought a property that commands top rent and will appreciate over time.  Dollars>Doors 

Use other people's experience!

[Robert McAllister]

Great post and all true, well written. I have seen too many fail. Inflation has put many properties out of reach for new investors as well!