Not all Investment Properties are Created Equal

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Did you know that you can buy a house in a number of different metropolitan areas for less than $20,000 right now?  And not just in areas with severely depressed economies like Detroit, but in economically viable cities such as Atlanta or Memphis.  Believe it or not, it’s entirely possible to buy a home in this price range, renovate the home for $10,000 – $20,000 and have a total investment of less than $40,000. This would have been unimaginable just three years ago, but with the crash of the real estate market, investors have been handed an unbelievable opportunity to acquire deeply discounted investment properties.

With the tremendous number of investment opportunities available today, many investors find themselves wondering where to begin. Some investors discover that it may not make sense to invest in their own market, so they investigate opportunities in other states. Other investors find that there are so many investment opportunities specific to their area,  that they become overloaded with information and confusion sets in. Whatever the case, investors intuitively know that there are good investments to be made right now. What is really interesting, however, is the vast universe of information and opinions that exists concerning where and what kind of investment property is right.

I’m hesitant to say that there is a specific right or wrong answer to this question.  It does seem to me, however, that many investors have formulated opinions based solely on surface level information and minimal experience.  Take the “Go Zone” for example. There was much appealing information back in 2006 being circulated about the tax benefits of investing in the “Go Zone” in Louisiana and Mississippi after Katrina. But ask someone who invested in a new construction home how that investment turned out and you will likely get a story about entire neighborhoods that are vacant to this day.

I see some of the same mentality today in buying investment real estate. “How could I go wrong buying a renovated house for $35,000 that would cost over $100,000 to build new?” The truth is, if you aren’t careful with your buying decision, a lot could go wrong.  While there are a number of locations around the U.S. where you can buy and renovate a house for $35,000, I am fairly certain that only a handful of those properties actually make stable investments.

I think one of the most overused and perhaps slightly misleading concepts that perpetuate poor investment decisions is advertised “cash flow.” Let me first say that I don’t believe there is anything wrong with buying a property with the objective of cash flow. I wholeheartedly believe in buying investment property for both short term income (cash flow) and long term growth. However, I do believe the term “cash flow” has been abused and is often-times misleading to new investors.

For example, buying a renovated home for $35,000 may seem like a no-brainer, especially if you’ve been told that you can get a conventional loan and still generate $400/mo in “cash flow.”  However, what happens when you can’t find a renter willing to live in your house or even your neighborhood? If the house sits vacant for any amount of time, what are the chances it would be vandalized? Or, perhaps you were able to place a tenant, but they end up causing more damage to the house than the security deposit will cover.  At the end of the year, you may find that while your initial investment for this house was minimal, the ongoing expenses and/or vacancy cancelled out any “cash flow” you initially had expected.

Again, let me stress that every market is different; many with very inexpensive homes in stable rental markets and attractive neighborhoods, and others where the properties are not so desirable. You might consider, however, that a more profitable investment for a particular market may be in an area with slightly higher prices, less (perceived) monthly “cash flow,” and more stability in terms of crime rates, renters, employment, etc.

New investors can often be enticed into bad investments because they simply haven’t done their homework, and they haven’t experienced all of the pitfalls associated with owning rental property. Understanding renters, vacancy rates and risks factors associated with an area is of utmost importance when determining where and what your investment should be.  Regardless of the type of investment you select, keep in mind that when comparing different types of properties, metrics such as advertised “cash flow” may not be a true apples to apples comparison.  You need to take the time to dig deep, collect information, consider your options and, then, make a calculated decision that makes good business sense.

About Author

Ken Corsini

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

9 Comments

  1. I’m not sure how long those inexpensive homes in stable rental markets with attractive neighborhoods will last on the property market. Won’t all the local real estate sharks swoop in and pick off these types of properties from the market before your average investor even blinks?

    As for those $35,000 properties that people say will generate steady cash flow, they sound too good to be true – and judging from your article they probably are!

  2. Mark Anderson on

    Good article Ken. I live and invest in Memphis and agree 100% with what you are saying about low priced properties. Nothing but headaches. Out of state investors call all the time asking if I can help them get out of a bad property they bought for five, ten or fifteen thousand dollars. Its the same story every time: high vacancy, high maintenance, vandalism, etc. I definitely recommend people should stay away from the cheap stuff and look in better neighborhoods. The overall investor experience will be much better.

    One great thing about the drop in values over the past few years is now you can buy in neighborhoods you were previously priced out of. These are the same neighborhoods you will be priced out of again whenever the market turns around. Try to take advantage while you can instead of snapping up low end properties with tons of future problems.

  3. Good points in this article. I totally agree with you about buying a “good value” property somply because it has good cash flow. It is much better if you are in it for the long haul to get into a better neighborhood with or without modest cash flow. A long term investment in a great neighborhood today will pay back a more stable turn years later after the market turns around. You will always have a good investment with or without the cash flow.

  4. Alex Cunningham on

    Hey Ken. I think this is a valuable perspective and has some great advice. Having owned properties in neighborhoods exactly like the ones you describe for many years I can say that you are generalizing quite a bit though. I do think it is good to have a diverse portfolio of properties in varied areas, but new investors starting out may only be able to afford an inexpensive home (if paying cash), or even if they are getting a loan. I wouldn’t want you to scare newbies away from getting started. Just because a house is in a lower income area (e.g. lower middle class to working class) doesn’t mean you are going to be guaranteed to have huge expensive problems. Granted some tenants can be terrible, but that is true anywhere if you don’t screen them well. Does anyone remember the movie Pacific Heights? Section 8 tenants can be great. So can blue collar folks. You do have to do your due diligence and not gloss over issues you find in their work, rental or criminal history. Past negative behavior is indicative of what’s to come in my experience. Also, while these areas may not appreciate in the same way as an upper middle class B or A neighborhood, I don’t know why people talk badly about the cash flow from cheap homes. Here is how I am seeing it. You should be able to cash flow $200/mo (with financing in place – much more if you paid cash, obviously) on that $40,000 place you refer to, including putting some money aside for potential vacancy and maintenance (I put 20% aside myself). Assuming a 25% down payment of $10,000 you are still looking at a 24% annual cash on cash return ($200 x 12 months = $2400). You have a tenant paying off the loan for you and will have your entire investment back in just over 4 years. Granted it doesn’t ALWAYS work out without a bump in the road or two, but I have found that more often than not cheap homes (in good rental markets) can be a good investment and a great way to learn a lot about real estate investing while starting out with little money to invest.

    • Ken Corsini

      Alex – I tried, but apparently failed to stress that not every inexpensive investment property is a bad one. I definitely don’t want to “scare newbies away from getting started,” but I do hope that new investors will take the time to perform adequate due diligence on any investment property … especially ones that have more potential for volatility.

      • Alex Cunningham on

        Thanks Ken. I totally agree. Doing your homework on the area and prospective tenants is essential. Many inexpensive neighborhoods are terrible investment areas. Cheap is not always a good thing. Talking to your team of local contractors, property managers and realtors is really great too. They are a great source of info about an area and what kind of tenants and possible issues to expect. Rule of thumb, if your local team doesn’t want to work in the area for any reason, (e.g. fear of theft of their car, tools, etc., vandalism, deadbeat tenants or whatever) steer clear. Sounds obvious, but sometimes your brain gets clouded by the POSSIBILITY of big returns and you forget to listen to the professionals on your team. Thanks again!

  5. This article has a lot in common with Jeff Brown’s recent article, I think. Even the cheapest property isn’t worth your time if the neighborhood isn’t desirable. There’s a strong impulse in real estate right now to claim that there are tons of Absolutely Amazing Investment Opportunities out there – but most of them are simply too good to be true, one way or another.

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