Approach to investing in lower income areas
Accountant · cedar rapids, IA · Member since 2013 · 99 posts · 46 votes
Just wanted to get opinions on how people approach investing in low income areas. I've heard people who have done very well investing in these areas and others who tell you say don't even consider it. My current properties I would consider to be all class B properties.
Some questions I have are:
What are cash on cash returns you would expect? cap rate? Do you put them on short notes and pay them down fast?
I generally buy properties really cheap, fix them up and rent them out. I would call this in "lower income" because no one I rent to makes more than about $40,000 per year.
However once I get done with them they are no longer "low quality" properties. I try to make everything something that I personally would live in. It might not be my preferences but at least I would live there. (I personally think a "slumlord" is someone who doesn't maintain their properties and wouldn't live in one of their own places.)
I also screen really well in order to get good tenants. Screening is critical. For people that don't make much money, usually a credit score is not something they ever learned about or know about. So I look more at other factors:
- Criminal history - especially nothing to do with drugs
- Eviction history - don't want it but I have taken people with one eviction in the past
- Rental history -- are they hopping from place to place every year? What do their prior landlords say about them? (Note that is plural.)
- Income -- do they have sufficient income to rent the place? Are there outstanding judgements against them? How long have they been at their job?
I have yet to know anyone that has a crystal ball to know if their tenant is going to stay at or lose their job in the future or if they're going to have medical issues, etc.
In my area, the two most commonly cited reasons about why people are moving:
- Landlords do not fix things.
- Landlord is going to foreclosure and they need to move.
So in my rentals, I combat that by:
- When things break, fix them in a decent amount of time. Be responsive. My tenants really like to text, so when they need something, they text me. I text them back.
- I let them know up front when they go to rent that I hear that all the time and that I'm growing and expanding and getting new properties. I'm not going anywhere.
I live in the same zip code and within about 3 miles of where my properties are. People know that I'm not off in some fancy suburb somewhere, I'm right there.
Hi Tyler,
I am interested to see what type of feedback you get on this question. Ironically I was just discussing this topic with my husband earlier today. I have yet to close my first deal so I can only offer my opinion. Personally I would rather invest in lower income areas. My reason being I am looking to purchase relatively cheap properties and want more cashflow initially. Although there are many horror stories, I am also not at all against section 8.
Ranae
Greetings! I specialize in low income areas. If I had it to do over again, I would invest in the better pockets of low income areas, because I must admit that I am a little burned out this year. We are in it for the returns, but are also passionate about providing solid (safe and clean is our motto) low income housing options and revitalizing the neighborhood.
If you manage them yourselves, be prepared for a lot of time and headaches. if you turn them over to a PM, be prepared for a lot of vacancy. The low barrier to entry is great, as is not needing to spend money to get them all gorgeous each tenant turnover, and we have never had to go through evictions - this population tends to disappear in the night or accept our cash for keys offers rather than stay and fight. But tenants in this strata don't have any credit to protect, and often don't have a clue how to take care of a property, so we have lots of noncollectable amounts owed and general frustrations. It is difficult to stay compassionate or even objective when immersed in generational poverty.
Cash on cash is not a measure I track, I'll have to play with it when I get some spare time. We target and get about $100/month cash flow per door. We target 10% cap rate and are getting about 9%.The Section 8 Bible is a great resource, and entertaining reading.
Hope that helps provide at elast one perspective!
I live in a small town so we don't truly have ghettos, but the smaller less appealing rentals in the worse parts of town make more money per gross before expenses, BUT they are the biggest headaches of all my properties. I spend more each time someone moves out and they still are rough when the current tenant moves out. Whether it is lack of money, the way they were raised or just plain lazy, the properties that rent for $350 to $500 per month get beat up way more than the $700 per month. They are easier to buy due to price, but they never seem to appreciate either.
This is an area we are exploring but do not believe we are yet knowledgeable enough to take the plunge into such a neighbourhood. We have a working class tenement, but it is still a couple of rungs up the ladder from the clientele we would have 3-4 streets over.
@Al Williamson could bring a lot of experience and advice to this thread on how to approach such neighbourhoods positively ... to give the neighbourhood a leg-up rather than simply prey on them as so may do.
Thanks for the heads up @Roy N.
@Tyler Smiarowski and @Ranae Richardson I've got a books worth of information to boil down for you. Here's an approach to max cash flow with increasing ease of property management:
1. Make the mindshift to view low income rentals to be apart of an inner connected ecosystem.
2. Recognize that as an inner city landlord you hold a high leverage position and can greatly affect the neighborhood. It's just like placing ice on your wrist will cool off your entire body - a catalytic landlord can improve a neighborhood.
3. Practice the 8 Habits and other milestone sensitive strategies to improve the neighborhood surrounding your rental holdings.
4. Enjoy strong cash flow, easier to manage tenants, AND appreciation that result by improving the area's reputation (lifting the stigma).
So, if your area of interest looks to have potential, consider joining the catalytic landlord movement. Best of landlords with long term interest - buy and hold types.
Hope that helps.
I generally buy properties really cheap, fix them up and rent them out. I would call this in "lower income" because no one I rent to makes more than about $40,000 per year.
However once I get done with them they are no longer "low quality" properties. I try to make everything something that I personally would live in. It might not be my preferences but at least I would live there. (I personally think a "slumlord" is someone who doesn't maintain their properties and wouldn't live in one of their own places.)
I also screen really well in order to get good tenants. Screening is critical. For people that don't make much money, usually a credit score is not something they ever learned about or know about. So I look more at other factors:
- Criminal history - especially nothing to do with drugs
- Eviction history - don't want it but I have taken people with one eviction in the past
- Rental history -- are they hopping from place to place every year? What do their prior landlords say about them? (Note that is plural.)
- Income -- do they have sufficient income to rent the place? Are there outstanding judgements against them? How long have they been at their job?
I have yet to know anyone that has a crystal ball to know if their tenant is going to stay at or lose their job in the future or if they're going to have medical issues, etc.
In my area, the two most commonly cited reasons about why people are moving:
- Landlords do not fix things.
- Landlord is going to foreclosure and they need to move.
So in my rentals, I combat that by:
- When things break, fix them in a decent amount of time. Be responsive. My tenants really like to text, so when they need something, they text me. I text them back.
- I let them know up front when they go to rent that I hear that all the time and that I'm growing and expanding and getting new properties. I'm not going anywhere.
I live in the same zip code and within about 3 miles of where my properties are. People know that I'm not off in some fancy suburb somewhere, I'm right there.
Great input. I think a lot of this years burn out is on "taking chances" on borderline applicants and getting "burned". Stick to established criteria.
I recently heard a definition of a slumlord I liked - someone who knows there is a problem (run down unit, bad tenant, etc) and does nothing. If landlords don't enforce their rules, noone else will...
I would live in any of my units, but concerned I would not get enough sleep. I used to think I might and write book about the social experience and really dig into to @Al Williamson changes (I dabble in it now), but my husband has talked me out of it.
Thank you @Al Williamson I'm all in! This is the mission statement I wrote out recently for one of my business courses:
TGG Mgmt Mission Statement: We will inspire, empower and motivate individuals, families and communities to live to their highest potential through the giving of our time, services, and resources. These specific goals will be accomplished through the acquisition, rental and resell of residential and commercial real estate, and service based businesses that cater to the tastes and needs of our clients, without consideration of class or income level, as well as seminars and programs encouraging financial freedom and homeownership, designed to inform and empower. It is our daily goal to offer services, housing, and education that is affordable, of exceptional quality, and encourages unity and an overall sense of community.
After reading your blog, it served as confirmation that I am on the right path. Your input is greatly appreciated. I know quite a few investors that question why I have chosen my target areas. For me financially it makes more sense, but my primary reason is, those are the areas I relate to and I want the "neighborhood" back.
@Ranae Richardson thanks for sharing.
Our mission statement isn't as detailed, but this is how we start our application with hopes to weed out the problems and attract the applicants who care:
Our Philosophy:
We strive to provide affordable, clean, and safe housing, be fair with repairs, and improve the Highlands neighborhood. We respect our tenant’s privacy, and expect tenants to respect the property, neighborhood, and all rules of the rental agreement.
We cooperate with the Longview Police Department to maintain a crime free living environment.
All great answers how ever each area has it own challenges and investing in them bring those issue front and center while rehabbing do you have a house sitter to protect your investment. Good tenant screening is one of the best ways to find and retain good hard working tenants in these areas. Yes we all have the ones that leave in the middle of the night with out paying rent for the last couple of months because you tried to have a heart. Learn from them get back own your horse and continue trying to provide good rental to the masses at a profit to you.
Low Income areas can be quite profitable and as others point out are a different animal and take additional attention. I suggest going to IREM.org searching for ARM certified property managers find the ones that specialize in these areas.
Affordable Housing where people qualify for programs by income guidelines check your local Affordable Housing office for a description of the programs. They can include government funded programs to increase energy efficiency at no cost to you.
The exact location of the property is important. Are you looking at a street or is it a neighborhood. A neighborhood people take pride in their area. A street not so much. Poor people deserve a nice place to live its your opportunity to provide it.
Good luck
Paul
You ladies rock!
Let me know if you're looking for long term strategies. I would love to help. Many, well nearly every neighborhood that I've studies, go through the same process of transformation. PLEASE don't start from scratch!!!!!
Low income areas can be profitable but they can be tough too.
Hard to eliminate the headaches but you can minimize them if you do a good job picking your residents. Terrible residents can live in blue collar and high end places too so it is just the probability is a little higher the lower you go on the income scale.
I am like several others that I want to provide a nice, clean, safe and desirable place for my residents. I would live in any of my units if I needed to since they meet all those general criteria.
I'm pleased to see the responses here. Al and I have talked before about the social responsibility and bringing blighted areas up to S/A/H.
I can tell you that eventually slumlords lose, to what point I don't know, but they will find it hard to stay in that mode. We had a municipal project to evaluate growth and various aspects of the quality of life here. I chaired the re-development committee. Frankly, we targeted blighted properties by area and individually and targeted those properties for changes. Through various means of enforcement, economic pressure and regulatory changes about 200 properties were effected and one mobile home park was put out of business turning it into a park area. We got rid of sub-standard housing for the most part, but some will always exist with changes.
Guess what I'm saying is that if you fail to make a commitment to safe, affordable housing and the inter-play with the community, you'll be hounded out of business until you "get it". No one in government will have sympathy as such dives usually present health, fire and criminal issues and it keeps the potential tax basis lower. Here, I'd say slumlords of the past also had a hard time with evictions and obtaining judgments.
That said, lower income properties can be profitable. You'll likely make more from 4 50K properties than one 200K home, but you'll earn it too. There is an old post on this topic.
Getting involved with housing non-profits is also a good way to profit and reduce risks through their efforts of housing education. Another topic we have had, profits in non-profits I believe.
Certainly applaud all those wh try to make a difference! :)
I half-jokingly tell my wife that "I love getting hung up on!". By that I mean when I get calls about my property and I give my spiel about doing a credit and background checks, I get a large number of people hanging up on me.
When people come to look at my property and are super excited and are ready to sign right there and then I explain that: "We do a credit and a background check. We are not looking for perfect credit. We don't want to see any prior evictions or unpaid rent and we don't like to see unpaid utility bills. Everything else we take with a grain of salt. For the background check, we don't want any felonies in the last 7 years and no sex offenders. We also confirm all information on the application (job, income, prior landlords)." Many then suddenly change their tune and "will get back to me" about the property.
I love these situations as it means that my screening process is working as they 'disqualify themselves'. Screening is VERY important when working with lower income tenants. I hate to think about all of my hang ups moving into another unsuspecting landlord's property. It also gives you an out like the time the neighbors in the 2 family next to my house wanted to move into my house. They were pretty much everything you imagine when you think of bad tenants or neighbors and there was no way I was going to rent to them. Fearing retribution against my vacant house if I told them the "NO WAY IN HELL!" I was thinking, I gave them the spiel, told them it is $40 per adult or married couple to run the check, and left it at that. Everybody in their family came over and tried to sweet talk me into letting the 'Mom' of the group move in, and every time I responded by telling them, "I gave her the application, she needs to turn it in so I can start the check. I have an extra application here if she needs it." Shockingly, she never turned the application in. She never applied so now there can be no lawsuit saying that I rented to somebody of different race/sex/age/religion/family/income because she never applied and never got turned down.
Does anyone know or use a personality survey to screen tenants? Being in graduate school, I've come to appreciate some of these inventories for revealing more about a person's decision making processes, respect for authority, etc. I googled and found a website called Honest Renter. Would it be illegal to screen tenants in such a way? I know places of employment do it, and since homes tend to be privately owned it seems as though it may be a viable way to distinguish some tenant types from others.
I appreciate reading the mission statements from those of you that have them, as we fully believe that profit and mission should go hand in hand. Ours is "To Create Eternal Value by Transforming the Communities in Which We Live." Its short so we can remember it and apply it.
As to the personality survey, I was at a REIA meeting a few years back where someone spoke on that using something of that nature. Not sure on the legalities of it at all. We do let people know that providing false information on their application will automatically disqualify them.
Really, you could give them a personality test, but you need training to understand it, it takes skills that most LLs won't have. Experience in reading people is learned from interactions. Wish it were that simple. :)
Thanks for laying that all out about your rentals plan! Great help. Do you ever fix and flip to sell to those that want to be homeowners in lower income areas? My niche is in a lower-middle class area. Not really low income, but solid lower-middle. I'm finding loan and holding costs can be prohibitive to do flips for properties to be owner occupied in those areas even though the majority of homes on the street are already owner occupied.
@Jane George no I've never done a fix and flip, only landlording.
Most of the properties I've dealt with have been in C & D class neighborhoods. And yes, they are cheaper to buy, and usually cash-flow quite well, they do tend to have a lot more units turns than the A & B class properties I know about. I always allow for a much higher annual cost for units turns on the C & D class properties than I would otherwise. There's a 120 unit highrise I recently looked at in a D class area and it would have been a lot of work to keep it at 85% occupancy, and I was going to allow for 25 to 35% annually turnover in the budget. If you want to make the cash off the C & D class properties, you defintely have to be prepared to do the extra work.
Sorry I can't click and post a link, but you might search for "Profits in Non-Profits" similar discussion on working with other non-profits and rehabbing areas. :)
Great thread! We are just getting into low-income rentals.
We are also in smaller cities, so I think the "rough" areas aren't as "rough" as you might find in the major metropolitan areas. We just have five units at the moment, but they all rent for between $475 and $600 a month. We do use a property manager, so gives us a bit of a buffer from many of the headaches that come from owning low-income rentals.
We have a buy-and-hold strategy. We look for 2% rent to purchase price, $200 cash flow per door and 30% return on cash investment (with a mortgage). In our market, appreciation isn't likely, but the purchase prices are low and the cash flow numbers are good.
Our heart is make a profit, provide safe and affordable housing and to give back to our tenants. We're exploring ways to do this. One is just giving a gift card in December no matter how long they have been with us or if they are current on rent. As we build a larger portfolio we're also going to look into offering them a free month of rent if they complete a financial management course.
Mike