What numbers/conditions would it take for you to buy in a ghetto?

9 Replies

I'm looking at a small apartment complex where based on my numbers the cap rate could be around 25% and the COC over 70%. Rents are around $450. It's also mostly renovated, just needs 10k - 12k left according to the seller. Only problem I can see is it's in a higher crime area which so far I've been completely avoiding. But now I'm wondering if in this scenario it could be worth it?

Also are there ways or steps you can take to mitigate the downsides of high crime areas?

Low rents and high crime area. What can possibly go wrong?

What occupancy and expenses do you base 25% cap rate on?

Expenses do not depend on rents. Forget that "50% rule". Your expenses should be $4000-5000/year/unit. Your rent is $450/mo or $5400/year assuming 100% occupancy. 

What can possibly go wrong?

@Jeff Mills Is it high crime with a lot of violent crime and murders ? Is this an area in your state or buying out of state ? The problem is you will likely have more vacancy, turnover , wear and tear and possible vandalism to your property and units which can add up a lot . I am also curious about how you calculated 25% cap. There can be money made in these areas but I believe it takes knowing the area well and being hands on . Many property managers might also not want to deal with managing in these areas or at least it can be hard to find decent ones .

@Joseph M. Looks like a good number of assaults and theft. Don't see any murders. This would be an out of state purchase. Ya, I've read plenty about the reasons for avoiding areas like that and I guess if you hold it long enough those costs are going to make it not worth it. My calculations were probably overly optimistic. The list price is $90,000 for 6 units at around $450 rent and they would be fully renovated.

Normally I've just completely ignored anything in an area that was high in crime at all but I had just read a part in The ABC's of Real Estate Investing where he talked about buying a property in a bad area and things they did to turn that around. One that stuck out was they hired off-duty police to patrol the area. There were a number of other things but I'm sure for a 6 unit complex none of them are worth it.

I was just wondering if there were any experienced investors out there who had exceptions to this rule and if they had strategies to make it work. Probably not the type of thing for an inexperienced single investor from out-of-state to take on :)

@Jeff Mills , How about taxes? Utilities ? Are they included or does the tenant pay? 

Yeah that makes sense on a larger property there are economies of scale so hiring security cost per unit wouldn't be as expensive. 

Myself I'd consider if it seemed like an area that has potential to change ..like if it's on the edge of a  hip or hot area or the city has plans to invest and revitalize the area . Have no idea where this is of course I'm guessing midwest somewhere? 

Take a look at an area like Over the Rhine in Cincinnati,OH.. properties were dirt cheap not too long ago..but now pretty expensive especially for Ohio . The city had a plan to revitilize and it worked out . It used to be one of the areas for the highest amount of murders . 

I think looking for areas like that before they get too hot , is a good strategy...but I know can be hard to find.

Here is a good article about what happened in Over the Rhine .

How Cincinnati Salvaged the Nation’s Most Dangerous Neighborhood


@Jeff Mills the basic problem with rents in that range: $450, is that variable expenses quickly eat up any profit. And thats true even if the building is basically free. This is why they fairly much give away houses when rents get that low, there is no money to be made unless you are willing to slumlord it and collect rent personally with armed security or relie on section 8 only

I have a weird attraction to the word Ghetto because it is most often used incorrectly. Believe me, I am anything but the grammar police but this is a word that I always gravitate towards in real estate because it means so many different things to different people. Technically speaking, it's "a part of a city, especially a slum area, occupied by a minority group or groups."

I say that not to prove you are wrong, but instead to point out that buying in a "Ghetto" means different things to different people. So, what is it? is it a drug neighborhood,? notorious for murders? maybe just a poor neighboorhood? a neighborhood full of immigrants? or, is it just a bad building in a bad neighborhood? 

I think the only answer is are you equipped to deal with the issues that need to be corrected, in order to make a profit on the building. If the numbers look right based on what I feel I can reasonably handle, then I will buy anywhere. I am also a large fan of stepping outside my comfort zone to learn new things, but it has to be done within reason. 

@Jeff Mills

I do not buy in D or F neighborhoods regardless of the numbers. There are still 2-3% rent ratios to be found in Cincinnati, there are 15% cap rates or higher in some areas. I still would not even consider those, here is why:

These types of properties will almost certainly require significantly more time to effectively manage, even if you hire a manager, they wont or do not want to manage in these areas (its more work for less money, to due to lower gross rents). Your vacancy rates on average will be higher, your expenses will be higher, usually landlords pay more utilities, there is much more risk of your investment. Tenants are less likely to pay rent or on time, it is harder to find quality tenants, you are more likely dealing with subsidized rents (which is another time suck). Furthermore, the ceiling on raising market rents is much lower, which means less value add to any multifamily. Overall, you might make more money than a C or B neighborhood, but not always after all things considered over a long enough timeline. Even if you did make more money, the amount of time and stress invested in D or F properties would not be even remotely worth it to me. 

I know a lot of investors who love this market and make money, but they have a massive hands on management team, and large contractor crew of employees, and its still difficult with massive capital reserves. It is possible, but I would not recommend it for 90% of investors out there. 

I have done it and it is not worth the hassle. I just sold one in a rough area that I bought in 2010. Cash flow on paper was $550/month for a SF home. Actual cash flow since 2010 was just over $500 total. Profit on the house was $35,000, but I bought at the lowest point in the market, did a renovation and sold just a few months ago. Had I bought in a different neighborhood, my profits would be doubled, plus a lot less headache.

More often then not, your on paper cash flow will look good, but what actually comes in will be bad.