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.

[Theresa Harris]

People need to stop focusing on the number of doors and look at the type of house.  Doesn't have to be the best area in town, but it needs to be something good-and safe.  While my rentals are not the most expensive homes in town, they are good 'starter' homes in good family friendly areas and I'd rather pay a bit more than a house in a rough area.

[Eric James]

Your post should be required reading for all OOS investor wanna be's. The problem is they don't want to listen. They don't want to let go of their dream of being an investor but they don't want to move to a place where they could do it locally. BTW, quite a few of the problems you mention aren't specific to cheap properties. They are likely to occur with all long distance investing.

[David Song]

This is a great post, very well written. Unfortunately most newbies do not want to listen to honest words.

[Dan Maciejewski]

Great Post!

From what I've seen generally, the great CoC and Cash Flow investments seem to eat all that cash flow right back up on the turnovers.

Some people trust the numbers so much that they forget that this is also a people and service business.  The customers can make or break you.  

A great investment involves a lot of research and new investors should never go to war zones or out of state for all the reasons you laid out. 

[Christopher Blanco]

Good post! Best to partner with someone in the area you are looking to invest in. They know the area well and can provide you with your boots on the ground and still get you a great return on your money, 

[Jonathan Oh]

Love this post. I see many new OOS investors fall for "great on paper" deals without fully understanding the location.

[Marcus Auerbach]

Originally posted by @Theresa Harris:

People need to stop focusing on the number of doors and look at the type of house.  Doesn't have to be the best area in town, but it needs to be something good-and safe.  While my rentals are not the most expensive homes in town, they are good 'starter' homes in good family friendly areas and I'd rather pay a bit more than a house in a rough area.

 Exactly! I could not agree more Theresa, my wife and I have a rule that we don't buy a property we would not feel comfortable living. We ask the same question when we decide about remodeling. And no, of course we don't buy houses in the top neighborhoods. Positive cash flow is still a requirement, but I have learned from my own mistakes and from many others what areas and types of investments to stay away from!

[Marcus Auerbach]

Originally posted by @Christopher Blanco:

Good post! Best to partner with someone in the area you are looking to invest in. They know the area well and can provide you with your boots on the ground and still get you a great return on your money, 

 I always tell people to invest at home. If you are from Cleveland, then invest there! You will have the homefield advantage and that is huge! I get it, the Bay Area is tough, LA as well. But it does not make sense for a Chicago investor to buy in Milwaukee, which is technically OOS - the economic difference is not big enough to justify the extra cost burden! If you want to invest in Milwaukee, move here, buy a duplex and move in! 

[Mike Dymski]

I saw a 1%'er in a linear market with no value add listed in the "Success Stories" forum the other day.  That's a success story...for the seller.

[Jay Hinrichs]

Originally posted by @Eric James:

Your post should be required reading for all OOS investor wanna be's. The problem is they don't want to listen. They don't want to let go of their dream of being an investor but they don't want to move to a place where they could do it locally. BTW, quite a few of the problems you mention aren't specific to cheap properties. They are likely to occur with all long distance investing.

this scenario is really a function of what I call the dream merchants..  For whatever reason there is this dream and its spit out verbatim by newer investors that the sole goal of buying these is to quit the job they hate and live off of rental income.  this is just not reality the vast majority of cases.. Investments are just that investments unless your going to do this for a living the idea that someone else is going to run your investment to move you into retirement  just does not happen all that much.

Can you switch career and make landlording a career move sure that can happen but you want to generate sales commission income as well and some flip income as well and so on and so forth.. just living on cash flow is pretty tough unless you can scale fairly quick and fairly big.  IE create company that does it for a living dig in and work

And RARELY works if your targeting properties in an MSA at 50% of the median price point.. those are priced for risk and you will suffer the risk of owning them 95% fo the time.

[Matt M.]

@Theresa Harris

@Marcus Auerbach

I totally agree. I would not buy anything that I wouldn’t live in.

I used to know two landlords that got permits to carry for rent pickup days. Yeah, no thanks.

[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. 

[Matthew Paul]

You Nailed it .   

[Luciano A.]

@Marcus Auerbach

Great post. I agree. I find it funny how someone will be willing to pay $$$ to buy and rehab but will not spend the money for a plane ticket to go look at the asset. I think IG/Facebook/Books give the false impression investing in RE is like investing in Stocks. You buy, pay others to fix and manage and you become rich. I will only invest in places I feel comfortable driving to at night or on weekends. If I am not comfortable going then not a place for me to invest in. Emergency calls/repairs dont always take place from 9am-5pm. 

Today with syndicators, crowdfunding, and such, newbies get the wrong impression. Those who don't do their homework will get crushed if the market turns. Like in CA, at the height of the market I would hear the waitress at Denny's telling me she got two rentals, losing $400 per month but plans on selling in one year and making $100k. Buying a cheap property doesn't always work out in real life as it does on paper. IF it did why aren't the guys investing longer than you the "newbie" not buying them all up themself. 

Just my two cents. From someone who chased the low-end prices but was only able to make it work as an active investor not passive. 

[Brian Garlington]

Great post Marcus. Of course anyone that would "buy" a property for 5K and then "fix it up" needs to have their head examined.

[Michael P.]

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 whole plan. Budget is 80k per house.

Flip side of the coin, this is exactly what I’m doing in Toledo (live in Maryland never visited) currently up to 40 doors and it’s going great. I could retire if I wanted but I have no reason to since I like my job and having multiple income streams.

[John Patton]

@Marcus Auerbach

Great post. I agree that it should be required reading for newbies.

I believe in follow the schools. The good customer/tenant wants good not great neighborhoods and schools.

Good stuff 😎

[Brock Mogensen]

Totally agree! Too many out of state investors buying on a budget and assuming best case scenarios in underwriting.  Best lesson I've learned is don't buy on a budget and underwrite conservatively. 

[Jesse Thurston]

Love this post. More goes into real estate investing than people realize. Numbers can look good, but not always true. I have seen this happen to friends even after people have told them not to proceed. It's hard to be push people away from something they believe in though as you want them to be a successful real estate investor and the best way to learn is jumping into it.

[Jay Hinrichs]

Originally posted by @Brian Garlington:

Great post Marcus. Of course anyone that would "buy" a property for 5K and then "fix it up" needs to have their head examined.

well that was what Clayton MOrris did he bought houses for 2 to 10k said he would rehab them but did not then said doctors and nurses would move in to live there.. 500 to 700 people bought into that story line.   And we know where it ended.. with him and his wife living in a upscale ocean front city in Portugal.. so maybe not very bright minded on the assets he bought and promoted but sure was smart to get out of dodge ahead of all the litigation..  So the names change the outcome is the same.

[Ryan Pyle]

Best post I've read in a long time. I've lived this...everything OP says is absolutely true. There's a reason the house costs less than a car. 

[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. 

[Brian Garlington]

Agreed............and now Clayton Morri$ is......oh never mind.

[Mark Brown]

@Marcus Auerbach. I’ve been investing in real estate for 16 or 17 years now and there’s a lot of truth in this post. The numbers can look fantastic on paper but the numbers don’t reflect the human factor. From tenant quality, contractor quality, pm quality, etc. The fact is the best tenants, contractors, and property managers all don’t want to live and work in a slum area. And since they got the capability to live and work elsewhere, that’s exactly what they do.

The only exception to this rule is if you can find a neighborhood that is truly gentrifying. Then the rising tide of prosperity can bring in the better people.

[Nathaniel Walker]

At the end of the day everyone needs a place to live.  If you buy a $5,000 house is a less than desirable neighborhood you should expect that your tenant pool and rent are going to reflect the product you are offering. If you want to win at this game as an hands off out of state investor you need to know how to play the game. You have to determine if you are going to be a wolf investor or a sheep investor.

Lets start with the purchase. A $5,000 house typically is not going to be rent ready/saleable so your numbers must include the costs to make it rent ready or saleable.  No matter how well you plan you will miss something like the $800 utility bill from the contractor's equipment or the city inspector's previous warnings to the prior owner.

The wolf investor never buys a $5,000 property without and edge. The edge can be having a great on the ground team, great remodeling skills, a huge reserve of cash, insider knowledge of the property/ area, etc. (Wolf Tip: Be disciplined, build a team, get and use great checklists.)

The sheep investor hands an open checkbook to a realtor/wholesaler and says thanks for the opportunity.

Next, lets talk about the rehab. A $5,000 house is going to need a lot off work.

The wolf investor expects to have difficulty finding a good contractor, knows it will cost more than budgeted and will take longer so they plan accordingly. They know it doesn't matter if it is a handyman or a large national company you are going to get screwed if you are not prudent. (Wolf Tip: Get written detailed estimates, ask to see picture ID, control the money and kick him out early if he is screwing up.)

The sheep investor is so happy to find someone to do the work that they don't properly do their due diligence and gives money up front.

Next, lets talk finding a Property Manager.

The wolf investor knows that generally few property managers are interested in poorly renovated $5,000 houses in bad areas and looks for the least crooked property manager that he communicates with constantly.  He understands you get what you pay for and establishes upfront that he is only putting up with minimal BS, controls the money and has a plan B ready. (Wolf Tip: Establish rules on how much they are preapproved to spend of your money and assume your being overcharged if they are to busy to justify and document  the basis for the expense.)

The sheep investor looks at their $5,000+ polished turd house and is counting the rent before the first tenant gets identified but is so relieved to not have to manage it they overlook all of the obvious warning signs.

Ok, now that we have a property mis-manager we need a tenant.

The wolf investor knows his house is not going to attract the best tenants and so he looks for the the tenant with the most manageable issues.  Even in bad areas there are decent people. (Wolf Tip: Wait to find that type of tenant with significantly more to lose than the investor.)

The sheep investor is so happy to finally have a tenant that they never ask any meaningful questions or screen applications because they have a property mis-manager.

Finally, the time comes to sell the property typically because when things are going good it ok but when it is bad it is so bad.

The wolf investor knows he has a pig with lipstick in a less than desirable area so he looks for the newbie investor looking for a turnkey property in an up and coming area.(Wolf Tip: A buyer has to have something to distract them from the real issues of the house so freshly paint the first room you enter in the house.)

The sheep investor, who may have never visited the property until it was in chaos, dumps the property for whatever they can get and chalks it up to a valuable learning lesson.

Be the wolf and not the sheep and you can make these types of properties work.