The housing recovery is limping along slowly leaving many real estate investors wondering where to invest their dollars. Some speculation is even returning to the market with new investors looking to purchase, renovate, and resale distressed properties for short term profits. Owning a real estate investment brokerage allows me to see a variety of transactions, including retail flips from speculative investors, investors buying $8000 homes, renovating and placing tenants in them, and a higher quality purchase and hold homes closer to median home prices.
The later is a strategy that I believe right now is being overlooked by many investors.
There are many markets where you can purchase and hold homes at the median or even average home price and receive a positive cash flow with a traditional 20% down strategy. These homes, are out-performing many lower-priced homes from rental prices and home values perspective. Median-priced homes in most markets are 3 bedrooms, 2 bathroom homes, which offer good car storage. Usually this is the type of home most Americans desire to live in ensuring you always have both an available rental pool and an available buyer pool. This product offers real estate investors multiple exit strategies with the ability to sell it retail vs lower end properties which usually need to be sold to other investors.
In addition, median-priced homes are usually in areas low in crime, close to schools, shopping, houses of worship, and with easy access to employment.
The inverse of this is, of course, also true. I personally own properties at much lower price points as well. They took the hardest hit on rents and value. This is where I’ve seen a lot of investors get in trouble. The lower priced homes usually have households with limited to no savings or emergency fund. So when a tenant loses a job, the property owner feels that impact pretty quickly. Also lower-priced homes tend to be in older areas giving the owner a much higher rate of maintenance.
This is where investors usually make mistakes. The surface numbers can be very deceiving in real estate. When analyzing a real estate transaction many investors aren’t using vacancy and maintenance, or applying the same vacancy and maintenance numbers to homes that vary widely in price, age, neighborhood, size, and city. This can cause a pretty big disappointment when the cheap property you purchase is affected by socio-economic issues leading to high tenant turnover, criminal element, slow-paying tenants, and maintenance issues.
While real estate tools aren’t sophisticated enough to give you a perfect analysis, one has to make adjustments for these issues. I’ve seen many people advertise proformas with high cash flow on smaller, older homes in areas with high crime, poverty, poor schools, and with low rates of home ownership. One can argue that these can be good investments structured correctly and by applying the right metrics to ensure a more accurate projection of cash flows is achieved. These lower-end properties have become the penny stocks of the real estate investment business. If you get the perfect tenant who doesn’t feel the pains of the recession, maintains the home themselves and stays in the property for a long time, you could hit pay dirt. Similarly if you’re well-versed in Section 8 you can profit greatly in the lower-end homes.
The median-priced home becomes the blue-chip property. The blue-chip home has lower levels of vacancy and rents that have been buoyed by average people being displaced from their primary residence via foreclosure. In the market where my company is located average priced homes are selling for around $115,000. Obviously with distressed inventory out there one can purchase properties at lower prices than this, improve them and probably have equity that is more tangible than lower-priced homes. How can one possibly model a $115,000 home the same way as a $30,000 home? The $30,000 home (in most cases) will have significantly higher rates of vacancy and maintenance.
If you go up a step to the higher than average priced homes, you’ll notice those homes might offer stable tenants, usually high-end professionals who will reliably pay the rents, the values have plummeted drastically.
The cash flows may look lower on the surface than other types of homes but these blue-chip homes perform more reliably on maintenance, vacancy, and valuations.
Financing on blue-chip homes tends to be much easier than most any other price point for a number of reasons. First because the prices are low enough you don’t worry about jumbo loan pricing, rates, and restrictions. On the lower end not all lenders are lending on homes priced under $50,000 and at times have different rate table. In and around the median price nearly every lender offers investor loan products. Also I’ve found the appraisal issues are fewer because normal sales activity exists at this price point. When you have a lot of normal sales, valuation tends to be (somewhat) stabilized.
Having an exit strategy is an essential part of your real estate plan. Some investors plan on never selling and while that can make sense to receive all the benefits of real estate, lives change. If you think back 5 years ago and how different things in your life were at the time, you might agree that having an exit strategy is important.
With these blue-chip investment homes, you’ll find multiple exit strategies. Median-priced homes have the widest available buyer pool. Think about that for a minute. Lower-end homes typically are resold to investors only in many cases and with the extinction of sub-prime lending; the rate of home-ownership in those neighborhoods is in decline. So imagine buying a home on the lower-end at 60 cents on the dollar and thinking you have a lot of equity. In fact if your future end buyer is an investor, do you think they’ll pay 100cents on the dollar?
Time on the market is also another factor. At the median-home price time on the market is usually shorter than any other price point. So in planning your long-term strategy it seems to make sense to invest in homes that could be sold quickly, financed easily, and sold at or near market value?
Where to Find
There are many markets you can find these types of properties in today. Without going into much detail on this post, there are plenty of cities which lie in states outside of California, Nevada, Arizona, and Florida which were impacted very little by the housing boom and bust. Many of these cities have a good economic future, affordable tax rates, net population growth, and high enough rents to achieve positive cash flow at the median home price.
With distressed properties making up a large percentage of total sales, then it only makes sense to focus on buying blue-chip homes at a discount today. In doing so, one can realize equity through quality renovation, placing a tenant and holding. These homes should provide you relative peace of mind when compared to lower price points due to the lower socio-economic risk discussed earlier.
These types of homes are a good fit for people looking to diversify out of equities and accumulate a few properties. While they may offer stronger fundamentals than most properties they obviously aren’t bullet-proof. These are comparable to owning GE stock (GE registered no US profit last year). While you can depend upon these homes most of the time, the downside risk is usually minor price depression during an economic recession. Lastly, in many markets this type of product and strategy simply wasn’t an option when prices were higher. I doubt that very far into the future this opportunity will be as widely available again in as many markets as it is today.