Not All Investment Properties are Created Equal

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.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.