Investing in "slums"

I am looking at a deal that seems very attractive. Here are the details:

6 single family homes (750 sf each) in a bad part of town.
2 completely rehabbed and rented for $450 per month
The other 4 houses need new flooring and HVAC as well as stoves.
Purchase price for all 6 houses is $169,000. Figure $30,000 to rehab I would have a total of $199,000 invested and my gross rent would be $2,700 per month!

I would hire a property manager due to the location of these properties. Can you guys give me some feedback on (1) this deal and (2) dealing with low rent properties.

Thanks in advance
Leonard

Leonard,

This looks like a loser to me. It is definitely a negative cash flow deal, losing about $100 per month. I wouldn’t do it.

Mike

mortgage $1,350 (borrow $179k)
taxes 195
prop mgmt 270
maint. 150
insurance 115
TOTAL = 2,080 per month

Total rent = $2,700 minus 10% vacancy rate gives me a positive cash flow of $350 per month. Did I miss something?

your maint/repair/cleaning cost are way too low

if your in the low end like this, you need to be solidly cash positive becuase most of your ROI is going to be coming from that cash output

Ok, I follow you. Thanks for the info!

I just ordered the Section 8 Bible by Michael McLean and Nick Cipriano. It looks like some helpful info into these types of rentals

I agree w/ propertymanager. Doesn’t look like a good deal. Cash flow, if any will be minimal. Repairs/main will be higher than expected as well. Also, don’t forget about misc like water etc.

Also, a little off topic but worth mentioning, if the props are in a bad area of town then appreciation will be on the low side. Yes…It is tough to get the best of both worlds…ie…good cash flow along with solid appreciation but you should try and get at least one on your side.

Sounds like you are on track with considering section 8. check the fair market rents on the hud website for your area. That could be the difference between solid cash flow vs none at all. I know in my area section 8 pays much higher than the true market rents.

Just my 2 cents.

Thanks Deaaak. I will check Hud Rental rates. If you are getting higher than market rental rates, that has to be attractive. How many houses do you currently have rented section 8? What are your biggest headaches?

SmithInvestments,

You’ve been reading too much guru nonsense. I truly wish that the only expenses were the ones that you listed - BUT THAT’S ONLY A DREAM!!! In reality, you’ll have legal fees, court costs, evictions, set-outs, lawsuits, damage done by angry tenants, exterminations, entity maintenance, office expenses, fuel for your vehicle, and many, many more!!! The real world operating expenses are 45% to 50% of gross rents. With what’s left, you subtract the mortgage and finally you have the cash flow (or lack of it).

Good Luck,

Mike

Wow, Mike. Who screens your tenants? 50% of gross rent for operating expenses? OUCH!!! I have had two rentals and haven’t spent half of that. Anyway, thanks for the input.

I always see that 50% mentioned and I think it has to do with what part of the country you’re in. I’ve done my taxes and I know my expenses aren’t anywhere near 50% because my rents tend to be in the higher range of $825-$1500. I suppose if you’re only making $200-$400, maybe you’ll hit 50% as you probably average the same number of visits to a property no matter if you’re making $400 or $1500 a month. And of course gas and car expenses are a fixed number, not a percentage of rents.

Also some of those are worst case scenarios. My parents have rented out property for 20 years and we never had a lawsuit, only had to do one eviction through the courts in all that time too, the other evictions were basically telling them to scram and they scrammed.

Anyway, the only other thing you’re probably missing is the mortgage. Did you actually talk to someone who will give you one mortgage for 6 individual properties? That sounds like a commercial loan. Or 6 individual mortgages. Not too many places do blanket mortgages. I would certainly try and nail that down before you go further. There’s lots of lenders out there who will say sure I can do that loan and then when it finally comes time to do it, they can’t.

Another angle on the 50% number is I use a couple of different types of property mgmt co. My one that runs mainly big complexes are just use to calling out contractors for every little tenant complaint and you get billed out at $75 for a job that is $3 in parts and 20mins labor. You can hit 50% of gross rents pretty easily. On the other hand, another one of my co. (different area) has a great rol-o-dex of local handy guys who do the same job for $25 in cash. Some of my properties have lawncare included; some of the them have no grass to be mowned (mtns of Calif…just rocks and dirt), etc, etc.

With that said, you can bring that number down to 35% if you actively manage your cost/management co., maybe do some work yourself or don’t give crap and let your properties go into a state of disrepair.

The point is a lot of people UNDERESTIMATE cost. This is inheritant to a “bottom-up” type of cost estimate (for any project, not just REI) vs. a top -down raw figure like 45% of gross rents.

I got several dozen units in multiple states and have been doing this for >5 years and probably my long term average is ~35%, but there are variables based upon location, how I run my business, etc that influence that number. As I proposed previous, one should maybe use the 50% number as a starting point in your evaluation process and work over time to improve upon that number (and improve your profit!).

Smithinvestments, to answer your question. I am trying to get at least 1 section 8 tenant per property. That way if the rest of the tenants forget about their rent at least I have some guaranteed income to cover expenses.

Thanks Deaaak. I appreciate the response. I have been looking at the low income housing market here in NC and I think there are some opportunities, but I will only go section 8. That guaranteed check every month is the way to go!

Smithinvestments,

With only 2 rentals, you are still a newbie and you clearly don’t understand what the real expenses are. When I first started, I said the same thing and I believed all that guru nonsense. Looking back, I feel silly that I ever believed all that nonsense and that I didn’t find out the facts until I had been in business for almost 2 years. In fact, I had over 10 rentals before I ever had a single vacancy! However, now that I have dozens of rentals, I see things much more clearly.

Like everything else in real estate, the expenses are just about the numbers meaning that over a period of time and with a large enough number of rentals your expenses will trend toward the average. For example, I am currently running about a 1% eviction rate per month. At that rate, with only two rentals you could literally go years without having an eviction. With a little luck, you might even go decades without an eviction. However, if you had 10, 20, 50, or 100 rentals, that eviction rate of 1% would certainly result in a lot more evictions over time. The same is true of all the other expenses. Even with dozens of rentals, I still have not had a lawsuit (although we came very close this summer). However, does that mean that I’m foolish enough to believe that we’ll never have a lawsuit? NO! In fact, I’m planning on it - it is a statistical certainty.

Your view on Section 8 is also a little naive. There is absolutely nothing guaranteed about a Section 8 check. In fact, there is very little difference between Section 8 tenants and any other tenants. It is true that Section 8 will NORMALLY send you their portion of the tenant’s rent each month, but the vast majority of regular tenants will also pay their rent each month. Section 8 tenants are just as likely to refuse to pay their portion of the rent as regular tenants. Section 8 tenants are just as likely to suddenly move out (breaking their lease) as regular tenants. Section 8 tenants are just as likely to be arrested; do drugs; sell drugs; steal; and commit other crimes. I could list example after example of the above, but I don’t want to write a book.

The good news is that you don’t have to experience all this nonsense without at least being informed. Talk to other local serious investors (not other newbies). Look at the National Apartment Association website. Get the real story before you are surprised by the reality.

Good Luck,

Mike

Thanks Mike,

You are telling me that HUD’s portion of Section 8 is not guaranteed every month? I seem to be hearing otherwise. As for the tenants, there portion is small in comparison, surely they don’t want to risk losing their voucher by missing rent checks. Aren’t they also screened by HUD? I’m not saying everything is easy with section 8 rentals, I know it’s not. I’m also not going out and buying 50 or 100 rentals in the next 2 years either. If I get 5, I’ll be happy!

smithinvestments,

Yes, that’s exactly what I’m telling you. You are NOT guaranteed a Section 8 check each month. It is true that if the tenant stays in your apartment; doesn’t complain to Section 8 about their unit; your unit passes inspection; etc that Section 8 will send you a check. However, Section 8 tenants do stupid stuff - very stupid stuff - on average just as often as Non-section 8 tenants. For example, last month I had a Section 8 tenant that had been in the unit for only 2 months suddenly move out (violating her lease) because she wanted to shack up with her boyfriend. She lost her deposit and her Section 8 voucher over this, but the Section 8 checks stopped even though I had a 1 year lease - JUST LIKE REGULAR TENANTS. A while back, I had another Section 8 tenant get arrested and went to prison. Her “guaranteed” Section 8 check also stopped.

Next, Section 8 tenants are NOT screened by HUD, at least not in the sense that a landlord would screen a tenant. Section 8 tenants can be just about anything - from convicted drug dealers to someone with multiple previous evictions. It is very difficult for HUD to kick someone off the program and very easy for them to get re-instated.

Finally, your information that the tenant’s portion of the rent being small in comparison to Section 8’s portion is factually incorrect. The proportions can be almost anything. I have tenants paying anwhere from zero to 86% of the allowed rent. The amount they pay is determined in large part by their income.

I would strongly suggest that you learn the facts about rentals before doing any further investing. Ignorance is not bliss when it comes to business.

Mike

Mike,

I am on this website to gather information. I put this original post out there to be a little better informed. Thanks for calling me ignorant. I really appreciate that. Do me a favor and NOT reply to any more of my questions!

I think he is only trying to help you keep from making a expensive mistake. I am not even a noob but I see what he is saying to you.
I invested in the “slum” and don’t regret it.

I’m sorry you were a little offended by Mike’s reply, but basically he’s got some good advice. If I had a choice, I would choice a regular cash paying tenant over a section 8 any day. Of course I also run a credit check and if you run them on your section 8’s you’ll probably find that it’s not so great. And of course with anyone who doesn’t have good credit or doesn’t care about it, you run a great risk of them either doing damage or skipping out on you.

You should check out the local section 8 website for your area, mine also says that the section 8 tenants are NOT screened and it’s up to the landlord to screen them. Also my two section 8 tenants are usually late with their part of the rent and one of them is only paying $150 for their share, usually at least a week or two late. I mention it once in a while, but they always seem to have some kind of an excuse. Of course sometimes my regular tenants are also late.

Also check out one of my other messages, the worst part about section 8 is the annual inspections. I breezed through the last couple of inspections with just a few minor items, but the last one I dunno, I think the local office was going through some kind of audit and they came down on me like a ton of bricks, picking apart lots of little things that were also there last year but the inspector never said anything about. I think they exceeded their requirements and I’m currently in an arguement with them on whether various items should be labeled as failed while last year they were deemed marginal and passed.

Smithinvestments,

I’m sorry that you were offended by my post. Being ignorant simply means that you don’t have the facts and that is certainly nothing to be ashamed of. However, failing go get the facts when you clearly don’t understand them IS a shame and will doom you to certain failure (like the vast majority of other newbies in any business). Most internet sites, REI clubs, investment groups, etc. are full of newbies. These newbies will often recite any piece of information that they have, whether it is accurate or not. Sometimes this inaccurate information is corrected by a more experienced investor and sometimes it is not. Every important piece of information that you read should be checked with a reliable source. For example, nearly every piece of information that you posted on Section 8 (and a lot of the information that is posted on this newsgroup about Section 8) was/is wrong. Why? Because it is second hand information and someone’s opinion instead of the facts. A better way to get that information would be to get it directly from HUD. The same is true of the expense information. You can get it from the various gurus, who have a primary motive to sell you ever more expensive courses and bootcamps and therefore have every reason to minimize the expense numbers and maximize the profit potential. Alternatively, you could get the expense info from the National Apartment Association or another trade group, who have every reason to publish accurate information for their members.

A key point in any venture is to determine “who you’re listening to”. Find out where you can get accurate information. Just this little bit of work will really enhance your chances of surviving in business.

Mike