Is it better to do a rehab and sell a house or to hold it as a rental in low income neighborhoods? Or is it best just to stay away from them? The books I’ve read say to look for houses in nice neighborhoods.
Shaun,
Both the risks and rewards are higher in low income neighborhoods, at least from a rental standpoint. As with everything in business, look at the numbers before deciding where to invest. It is all about the money!
Mike
The books you’ve read are idealistic, assuming everyone has a 850 credit score and $5 mil of capital just sitting around to invest.
In the REAL WORLD, most investors start out in low income neighborhoods. Even seasoned investors cannot turn down the ridiculous yields available only in da 'hood! Don’t buy properties in the worst part, though, and if you do make sure you’re insured to the maximum as it’s just a matter of time until something (arson) bad happens (arson) to your property (um… arson?). It is a lot more hands-on as a landlord, but it’s usually worth it. I continue to buy on the fringe of low income neighborhoods and have continued success. I bought a 3/3 duplex 6 months ago there for $59,900 and it generates $1450 in rent each month. 20% down, so I paid $12,000 for this property. $300 a month mortgage, $200 in taxes, $125 in water, $100 in insurance. That means I make $725 a month off of a $12,000 investment, which is just ridiculous.
The cash flow and yields are much higher in low-income areas, but the appreciation level is lower. Well financed investors often opt to go with much lower yield properties in better neighborhoods which may actually produce negative cash flow to realize much higher appreciation levels. If you’re just starting out you need to know two things - 1) negative cash flow will kill you… and 2). Negative cash flow will kill you!
Start out in the low income areas, and stick to duplex units unless a great single family comes along. Try and buy all your low-income properties in a close vicinity to one-another, as it’s easier to manage them. From my personal experience, buy 3 bedroom units or S.F. houses as they seem to attract the better tenants which have a family. 1 and 2 BR places seem to attract worse tenants. Screen them all, forgoing the credit check as they’ll all have bad credit so it’s a waste of your time. Most important thing is just to verify from previous landlords that they weren’t evicted. Also, try and rent out to the most stable tenants… the ones who have worked at a job for at least 6 months, and don’t fall for the “Im starting a new job next week” crap. Beware any applicant that states their reason for moving is “Da previus landlawd didnt fix nuthin”. (Yes, that’s what they really wrote on the application, verbatim).
Most importantly, don’t ever over improve the property. You’ll tear your hair out when you see how they generally treat the place. Expect that you’ll have to do at least a minor rehab every other tenant.
Super ultra mosterest importantly, look up Section 8 housing in your immediate area and sign up. They’ll do two inspections a year of each property you make eligible to make sure they are in good condition, but after that the money will show up GUARANTEED via direct deposit in your bank account the 1st of each month. Generally the tenant will be responsible for some of the payment, but they will never be late either because they’ll get dropped from the program if they don’t pay, and there’s a very long line to get back in. They pay top dollar as well, and have maximum rates for what they’ll pay. In my area the difference from a 2 BR unit to a 3 BR one is over $150 a month, so it’s well worth the little bit extra it’ll cost you to buy a 3/3 duplex as opposed to a 2/2, as it’ll make $300 a month more.
There, now you’re ready to work in the ghetto! Just remember… DONT BE THERE AFTER DARK!
Thanks visual_underworld…i appreciate when you guys take the time to put these long informative replies. And that’s the answer I was actually hoping to hear. There are so many cheap houses in areas of baton rouge that I wouldn’t have thought of buying. It’s not so bad that you have to worry about getting shot when riding around the neighborhood…but, definitely not somewhere I would want to live.
after reading your reply I went to the neighborhood I had in mind. There were 3 sfh’s listed on realtor.com in went to look at all listed b/w 39k and 39.9k and owned by the same person. I drove by and the neighborhood is run down pretty bad. I just drove around the surrounding roads and saw atleast 10 vacant houses. The agent I talked to about the 3 houses said they only rent for around 285/mo. I think I need to do some research on section 8 b/c I have no idea what it is.
If they are all owned by the same person that means he’s an investor and you should ask yourself “Why is this guy selling all of his properties in this area?” The answer is one or all of below: rent amount sucks, vacancies are too high, or the area is already (or so to be) experiencing deflating property values. Even with a 0% loan you wouldnt be able to make a property cash flow if it’s only getting $285 a month! Vacant houses are also a magnet for crime and vandalism, such as people breaking in and taking all the copper pressure lines out of the house for their recycling value! Copper has risen in price over 50% in the past 12 months so this is sure to get worse! Avoid this area, and if you DO decide to buy here for whatever reason, don’t pay anywhere near full asking price. Im talking half of $39,900, if not lower.
Yea I guess you’re right. I mean this neighborhood is really bad. I would say about 30% of the houses I saw in the surrounding area were vacant and boarded up. May be a little too low income. I’ll keep looking.
Visual_Underworld,
I hate to burst your bubble, but you’re using some of that “guru” math. You are not making $725 a month off of your property - not even close! You’ve omitted a bunch of the real world expenses. What about vacancies? What about evictions and legal fees? What about lawsuits? What about damage caused by tenants? What about routine capital expenses? Don’t buy into the guru hype. You’ve got to include the REAL expenses if you want to know what your REAL profit is!
Good Luck,
Mike
Yes, you are correct. For the sake of simplicity I left out a few costs, but I also left off a few benefits as well, such as the tax credits and depreciation that help to offset any additional expenses.
Vacancy rate in Milwaukee is hovering around 5%.
Evictions/legal fees are extremely minimal as both units at that duplex are occupied by families collecting rent assistance under Section 8. They are only responsible for a small percentage of the actual rent, but if they don’t pay it on time then they will be dropped from the program and there’s a long, long wait list to get back in. Being that they are Section 8 tenants, the government basically did the screening for me as well, omitting a few more expenses.
Damage caused by tenants is covered by a double security deposit.
Routine capital expenses are negligible as the property was recently refurbished, however maintenance is important, indeed, and seems to amount to about $35 a month per unit.
Your point is valid, though, and every investor should be aware of ALL the costs of leasing/renting real estate… especially in low-income areas.
I’m a property manager of a large low income community. You can go to your states web site, or call section 8, to see what their max is for a one, two or three bedroom. We have about 12 move-outs a month, and 70%, need carpet replacement upon move-out.
The one thing that will save you tons and tons of money in the long run is to not put in carpet. If you don’t want to spend that much, you can get vinyl that looks like wood, and it has a 10 year warranty. If there is any damage, it will be replaced for free. I thought it would look bad, but I saw it at a brand new community, and it actually looked good! I started having it put in the kitchen and bathrooms, and am working on the owners to start doing that instead of every carpet replacement.
They will destroy your home, but with the leases we have, you can apply rent money to “non-rent items first”. So, you could do a monthly inspection, and if there is a kicked door, destroyed blinds, an engine in your living room, with oil dripping all over the place, you can fix it, then take their portion of their rent, apply it towards the damages, and then they have an outstanding rent balance, which they will take much more seriously (especially the accumulating late charges.)
That is an absolute OUTSTANDING idea about using the rent monies towards non-rent personal items.
As for the floor issue I realized that long, long ago. Only downside to having hardwood floors in most of my units is that it can get rather loud for the first floor renants if the upper have a number of children.
Thanks for great idea.
The edge of revitalization…
the lower income neighborhoods… well, i’ll admit, i’d prefer to not live there. there were times during my exodus from marital bliss (separation) that I was seeking someplace to live. Needless to say, budget being cut in 1/2, the ole “revitalization” area became a strong contender. Now, mind you… some wonderful investor came in and rehabbed a GOR-Gee -Us home - despite this, I wondered if my computer would be in the house when i got back from work… or my car in the same spot , undamaged, when i woke in the morning.
but i saw great signs. 1 dumpster for removing misc. poop. 2 someone beginning a rehab on a 6 er adjacent the house i longed for… etc.
no, i didn’t move in. and the advice about these tenants is right on.
i rented a property to someone and there were many months we were unpreparedly covering 2 mtgs. not fun.
soo… in my long winded comment - look for signs of revitalization. is the city/town/district pushing revites for the area? are other investors rehabbing /investing there?
Blondie,
You’re absolutely correct about the carpet. We paint the wood floors in all of our low income housing units - no carpet at all. If the tenant wants carpet, they can drink a little less beer and buy a throw rug.
Mike
Mike,
I once had a tenant ask to put a rug in a unit I was about to rent to her. I asked if she had a vacuum cleaner to keep ot clean and the answer was NO! Imagine them not cleaning up after themselves…
Aside from the carpets, have you guys experienced “perpetually plugged drain syndrome” yet? Because of this I state explicitly in all leases that beyond the 30 day point of habitation it is the tenants responsibility for all clogged drains.
You have no idea how many times I have gone to low-income units with clogged drains and found out it was due to direct pouring of grease down the kitchen drain, small toys or whatnot down the toilet, and them flushing non-biodegradable baby wipes and backing up the main line. At over $100 a pop to have Roto Rooter clean those lines it gets rather expensive.
You’ll be surprised what a coat hanger, baking soda, vinegar and hot water can do.
We started giving a plunger with a bow around it for a move-in gift. 
Blondie said
"They will destroy your home, but with the leases we have, you can apply rent money to “non-rent items first”.
I must say this is very sad. If you rent to a lower-income family, can you assume your house will be trashed? (excuse the generalization, I mean “in most cases”). I can’t imagine putting all the $ and time into a place and have it destroyed. Has anyone seen a difference with a lease-option, ie, do the tenants care more about the condition?
Yes, it is indeed assumed that it will generally be trashed. This is the reason for double security deposits and specific clauses in the lease that state “security deposit cannot be used for last months rent”.
The yields on these properties are very high for a reason. It’s a great place to start out but once an investor gets financially established I’d say that 9 out of 10 times they exchange these properties into better ones. They have lower yields, but much less hands-on maintenance and general headaches.
From my experience lease-options do not generally work with this grade of tenant. For whatever reason, low-income tenants have an inability to prepare for the future. They live day-to-day, week-to-week, and month-to-month. Not to be racist, but 95% of these tenants (at least here in milwaukee) are minorities.
I think that if they have good rental history from an “apartment community” verify through the fax machine, you will find a lot of people pay their rent on time, even though they may have bad credit.
Some people pay every month (within the month), but then get caught in the $125.00 per month late charges.
I think “lease option” is a great idea.