7 Pitfalls Cleveland Real Estate Investors Make and How to Avoid Them
As investors and agents ourselves, one of the most common questions we have gotten over the years is, “What are the biggest mistakes investors make in the Cleveland market?”
The Cleveland market can be challenging to navigate without the right team in place. These are the 7 biggest mistakes we see investors make.
1. Buying in the right area but on the wrong street.
2. Buying a property with assuming or not knowing of point-of-sale violations
3. Not knowing about Cleveland's Lead Paint requirements
4. Misunderstanding or not knowing of Cleveland’s tax abatement opportunities
5. Purley looking at Properties for Cash Flow and not taking the whole picture into consideration
6. Not taking into consideration the age of most Cleveland properties
7. Not understanding Taxes in Cities Around Cleveland
In the below article, I will break down each of these mistakes and how to mitigate risk with each of them.
#1 Buying in the right area but the wrong street.
Cleveland is a tough market to navigate. What do I mean by this? For example, you can invest in an overall C-class area, but within that city or zip code, there can be pockets of D-class streets.
For example, as of today, an excellent C-class area for cash flow with some appreciation potential is the Old Brooklyn / Brooklyn center area. Many of our clients have done very well in this area, especially off Memphis Ave. However, just a few blocks north of the Cleveland Metropark Zoo has become a tougher area lately. That is what we are seeing today as of 01/18/2023. As with a lot of areas, this will inevitably change over time but having an agent in your back pocket who not only knows the general area but knows street by street is crucial to your success in the Cleveland market. Having bad tenants that do not respect your property will crush your cash flow (more about that later).
The best way to mitigate this risk is to talk with an experienced agent and property manager. Property managers are a great resource as they are on the ground every day and are the first to know if a pocket of an area is changing for the better or for the worse.
#2 Buying a property with assuming or not knowing the point of sale requirements
Many out-of-state investors do not realize this, but various Cities around Cleveland require a point of sale inspection (POS for short). This is typically in cities where most of the houses are owned by investors as long-term rentals. Cities first created POS inspections to ensure proper upkeep of the property. This is how the point of sale works. Upon listing a property, the current homeowner must order a POS inspection. An inspector comes out and reviews the properties and takes notes of any violations. Within 2 weeks, the inspector sends the POS report back to the homeowner. From there, the seller can either fix the violations and have the property re-inspected after repairs have been made or have the buyer assume the point of sale violations. If the buyer accepts the point of sale, depending on the city, the new homeowner will have 90 days to complete all point of sale violations upon the transfer of the property unless the weather does not permit.
What we see investors do is assume the point of sale inspection without seeing the POS report. For example, in many cities having a garage is a requirement, or having multiple cracks in a single concrete block is a POS violation. What does this mean for the investor? They will have to replace that concrete block or build a garage. When you start getting into concrete work or building garages, this gets expensive fast. Say goodbye to your cash flow and cash on cash return.
Make sure you have seen the point of sale report, and if you are going to assume the violations make sure you have a licensed contractor registered with the city to give you a written quote before you close on a property.
# 3 Buying a property in a Cleveland zip code without fully understanding Cleveland's Lead Paint requirements
This is one of the most significant issues we see both in, and out-of-state investors make, as it is not often talked about in the Cleveland area. In the city of Cleveland, and only the City of Cleveland, all properties that are rentals complete the Lead Certification Process.
How the process works is if you own a rental in the city of Cleveland, the city will send you a letter stating you need to complete the lead certification process. You must contact a certified lead paint inspector, who will come out to test the property for lead paint and send his samples to a lab. A few months later, the lab results will come back as either positive or negative. If you test negative that is great news, and you are in the clear. If you test positive, however, you must go through the lead paint remedy process. This entails hiring a licensed contractor to remove all lead paint on the property. And this is not an inexpensive project. It can get pricey fast and get up to $20,000 to $40,000 or even more, depending on the property size. Lead paint is often found around older windows where the paint is flaking or on the older siding.
You can mitigate this risk in 3 ways.
- 1. During your due diligence period, send a licensed lead paint inspector to test the property.
- 2. Ask the seller if they have gone through Cleveland’s Lead paint process. If they have and the results came back negative, you are in the clear. Be sure to ask for the results and certification from the city.
- 3. Look for old windows and flaking paint during your walk-through.
Here are 3 Resources to learn more about the Cleveland Lead Paint process
Lead Safe Cleveland Coalition.
Cleveland's Lead Safe Certification Application
City of Cleveland's Website On Lead Certification Process
#4 Misunderstanding or not knowing of Cleveland’s tax abatement opportunities
A largely unknown fact to out-of-state investors is that the city of Cleveland has created a tax abatement program that allows qualified investors or homeowners to pay no property taxes for up to 15 years! Hello cash flow! In the words of the city, “The City of Cleveland’s Residential Tax Abatement program is the temporary elimination of 100% of the increase in real estate property tax that results from certain eligible improvements on eligible residential/housing projects (Remodeling or New Construction).”
The property must undergo remodeling or new construction. The idea behind the tax abatement is to stimulate investments in some city regions. This process is not an easy one, and there are many requirements. For more information, go to the link below or call the city of Cleveland to see how you can potentially qualify at 216-664-3442.
#5 Purley Looking at Properties for Cash Flow and not taking the whole picture into consideration
Many investors come to the area of Cleveland for affordability and price-to-rent ratios. Many investors are blinded by this and do not take into consideration all the aspects of Real Estate.
Cash flow is great, but it is only as consistent as your tenants are. For example, let's say you find a fully turnkey duplex in East Cleveland for $80,000. You can achieve $650 per unit per month in rent, which makes this property gross $1,300 a month and a 1.625 price-to-rent ratio! Sounds great, right? This is the mistake most investors make.
What we often see with these types of deals is that tenants pay rent for a couple of months and then stop paying. You are then forced to evict them and are out thousands of dollars in attorneys' fees, turnover costs, and lost rental income. You are burnt out and have nothing to show for it.
Moral of the story, investing in real estate has many considerations. Cash flow is one of them but investors need to consider the type of tenant they can attract because your cash flow is only as good as your tenant’s ability to pay rent.
#6 Not taking into consideration the age of most Cleveland properties
Cleveland properties tend to be older. Having 1890 or 1925 year-built properties is very common in the Cleveland area. Having older properties in your investment portfolio is not a bad thing but investors do need to budget for older homes properly.
We see out-of-state investors assume similar repairs costs for a 1960-built property to a 1920-built property. Unfortunately, this is not the case. Whenever a property is older, there are likely more repairs and maintenance needed on it. In essence, everything is going to cost a little bit more.
This is by no means a deal killer, and we have properties in our portfolio that are 1925 built that perform great. Make sure you budget property. A good rule of thumb is to assume repairs and maintenance will be around 5% of gross income.
A part of this is ensuring you know the age of all capital expenditures. We see many investors underwrite Cap Ex at a general 5% to 10% of gross income. When in fact, this could be much more or much less than reality. For example, if a duplex has twenty 20-year-old furnaces, a 25-year-old roof, 15-year-old hot water tanks, outdated electrical panels, and original plumbing, you will assume some serious capital expenditure costs. The price you pay for this investment better be reflective of that. On the flip side, if all of the items I listed above are brand new, you can pay more for the property and still achieve the same, if not more, rate of return.
#7 Not understanding Taxes in Cities Around Cleveland
Lastly, we see investors assume tax amounts and not look up the actual tax data. Certain cities around Cleveland have higher taxes than others. For example, Cleveland Heights, Shaker Heights, and Garfield's Heights, just to name a few, are cities with much higher taxes than within the city of Cleveland.
You must go to the county auditor's site and see what the previous tax bill was. And to also see what the tax bill was the year before that. If there was an increase in property taxes, there will likely be another increase to come. Make sure you assume that in your underwriting process.
Links to County Auditors Sites
Cuyahoga County Auditor's Site
Summary:
In summary, below are the seven biggest mistakes Cleveland real estate investors make and how to mitigate the risk of each:
1. Buying in the right area but the wrong street.
Mitigate this risk by consulting with an agent and property manager
2. Buying a property assuming or not knowing of point-of-sale violations
Mitigate this risk by making all offers contingent upon seeing POS reports, having the seller assume all POS violations, or getting a quote for a licensed contractor to make these repairs.
3. Not knowing about Cleveland's Lead Paint requirements.
Mitigate this risk by having a lead paint inspection. Ask if the current owner has gone through the lead paint inspection process or not buying in the city of Cleveland.
4. Misunderstanding or not knowing of Cleveland’s tax abatement opportunities
Do your research and talk with the city to see if you can get quality tax abatement opportunities with your investment strategy
5. Purley is looking at Properties for Cash Flow and not taking the whole picture into consideration
Do not only look at investments solely on a rent-to-price ratio. We recommend only investing in C or higher areas. Remember, your cash flow is only as good as your tenants' ability to pay it.
6. Not taking into consideration the age of most Cleveland properties
If the property is older, assume higher repair and maintenance costs. Also, know the date of cap ex-items and adjust your offer accordingly.
7. Not understanding Taxes in Cities Around Cleveland.
Look at the county auditor's site to see exactly what the previous year's taxes were.
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