Which is better investment? Better market value or better cash flow?

Question

hey folks, I'm a rookie so please be kind.  I'm wondering what you think is a better investment for a guy in my situation.  A single family home in a good area with a good possibility of the house value raising with $210 monthly cash flow (using 50% rule).  Or, a triplex, in a much less desirable area, but with a cash flow of nearly $550 per month (50% rule).

Things to consider: I do not plan on doing this full time. I am looking to make my FIRST real estate investment (other than my personal home). I would like my first investment to be a very safe purchase and am willing to sacrifice some cash flow for security until I get a better grasp of the process.

Thanks so much for any feedback. This site is awesome and such a supportive community!

-Teague D.

Raju Pothuraju · Answer

@Teague D. IMHO (going against the trend here) I would go with single family home in better neighborhood to build long-term wealth. Of course it depends on how much better location the sfh is in. I never had vacancy in my single family home in A neighborhood.

John Cohen · Answer

@Teague D.  cash flow or better market also depends on individual goals. If your looking to supplement your income cash flow is great. If your looking for long term rewards I would buy in a better market.

Steve Vaughan · Answer

I agree with @Raju Pothuraju and would go with the less CF, less headache house.  Especially as a first investment.  I have found the less desirable "high CF" properties to not appreciate and not turn out all roses like we would like.  One bad tenant will scare off your 2 good ones and eat a year's worth of CF in legal fees and damages @Teague D.!

Teague D. · Answer

Zach,

Thanks for the wisdom, man. Much appreciated.  Just had a friend move near Ravinwoods Rd... Great area.  Good luck in building your portfolio!

Teague

Zach Nelson · Answer

Teague,

From my experience with the Peoria area the 50% rule doesn't hold.  Due to the high property taxes it tends to be closer to 55 - 60%.  You should only use the 50% rule as a quick check to see if it's even worth analyzing the property.  After that, you need to do some in depth digging before putting an offer on anything, and that means not only asking the seller because they will paint a rosy picture.

One thing to look at is how the utilities of the triplex are metered.  If they're not individually metered for each unit (gas, electric, water/sewer, garbage), you will be incurring additional costs per month that will drop your cash flow lower.  You should be able to ask the seller how they are split, and the utility company should give you monthly bill averages if you tell them you are looking to buy the place.  I recommend doing some digging into other expenses as well, such as insurance, is it in a flood plain, taxes, etc.  If you call around to local property managers you can get an idea of rents and turnover (though it sounds you might already have that figured out).

About your other question, how I classify properties is as follows: an A class neighborhood is the neighborhood where everyone wants to live (take a drive way down Ravinwoods Rd in north Peoria to see what I mean).  These are going to have very nice houses with high end finishes, great location and schools, etc.  Very rarely is it possible for an investor to make money in one of these neighborhoods.

B class neighborhoods are ones where people want to live, but they aren't as ritzy as A class.  Typically these will be in good school districts (think Richwoods or Dunlap school districts) or close to jobs and shopping, etc.  The houses will be a step above a starter house but not a dream home, and you can potentially get tenants who will stick around for many many years.

C class neighborhoods are ones where people live because it's what they can afford.  You'll see a lot higher percentage of renters to homeowners, pride of ownership will be less, and home values and rents will be lower.  It still is a safe area though and you can find good cash flow, although your turnover will be higher than in a B class neighborhood and it's more work to manage (typically).

D class neighborhoods are starting to get dangerous, and people don't live here unless they have to.  You'll see high levels of unemployment and some crime, and will attract a much lower class tenant.

Stay away from F.

I typically try to invest in B to C class neighborhoods, and ideally I like to find a C class property (needs updates and repairs) in a B class neighborhood, but that's personal preference and it all depends on how much work you want to put into the place.

All that being said, I'm definitely a multifamily guy myself, but you do tend to get higher turnover and more tenant issues with multifamily properties, and they are more likely to call you to fix every little thing than someone renting a SFH.  Don't be turned off by the time on the market, that just means they have it priced too high and according to my realtor the average time on market for a house is 100 days.

Sorry for the extremely long post but one last thing, Peoria historically has very flat property values in most areas.  Make sure the cash flow is worth the investment, and never bank on appreciation.  It's a bonus, not the reason for making the investment.  One way to force appreciation though is to fix up a property, or take a multifamily property like the triplex and improve its cash flow (whether by generating higher rents or lowering costs), since multifamily properties are always bought by investors and are typically valued based off of their returns.  I'll stop rambling on now but feel free to reach out to me if you have any questions.

Best of luck!

Teague D. · Answer

Awesome. Thanks guys! Really appreciate the feedback.

Josh Mitchell · Answer

@Teague D.

To be honest, there is probably a reason it is sitting on the market. Dig, dig, and dig some more as to why. It may need alot of work, HVAC, foundation issues, etc. Maybe that is something you are comfortable in dealing with, but starting out, you may not be. Neighborhoods are usually ranked A, B, C, D, F with the best neighborhoods being "A" and so on. It is up to you how you classify areas and what you want to invest in, but for me, I usually try to stay in "C" areas.

Teague D. · Answer

Thanks for replying. I appreciate it.  I suppose I'm just a little intimidated by a triplex.  Also, it almost seems to good to be true.  As you said, there arent a ton of triplexes in the Peoria area and this one has been on the market for over 2 months.

Josh, what is a 'C' area? I'm sorry I should probably know this if even considering making an investment.

Austin Youmans · Answer

I agree with @Richard Redding and @Josh Mitchell.

Also run a full anaylisis and don't rely on a rule of thumb.

Josh Mitchell · Answer

@Teague D.

Agree with what @Richard Redding said to you. I do know your area, and while there are many parts I would tend to avoid, if the tri-plex is in a "C" area, then you should jump on it, for the reasons Rich mentioned above.

Which is better investment? Better market value or better cash flow?

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