High versus low cashflow rental properties

[fizbanco]

Hi everybody,
  I've only posted on here a few times, but I've been an on and off lurker since 2012.  I'm looking for advice on investment options.  Here is some background details on me.

I'm in my early 30's.  I run a small business and have been able to save quite a bit of money, though a considerable bit is currently invested in the business.  My business profit has been coming down some the last few years, though it is still likely alot better than I could earn through other vocations.  I'd say I'm somewhat burnt out with it, but there are still parts I enjoy.  I'm currently planning to keep doing it for another 3-5 years likely.  I'd likely loose alot of "value" in shutting it down (maybe 6-9 months profit) and I couldn't easily attain this level again once done.

So, on to investment questions.  This is currently how my money is held (very rough estimate).
20%- House (will be rental)
35%-Business
13%-Stock market
32%-Cash

I'd like for my money to be working the best for me as possible, also, I'd like to be setup for long-term fairly passive income when (or if) I give up full-time working.  I've thought of 100% stocks/bonds, but 3-4% a year isn't enough to fund my life currently.

My current house is in a nice area, 3-bedroom and will be nicely fixed up.  It will likely bring in about 0.85% of rental income a month.  That is about average for this area.  Prices are fairly stable, but increasing slowly.  Quite a few good jobs in the area.  If I was to keep all cash in the house I'd expect about 7-8% returns.  If I financed I could get about 12%, plus any appreciation.

Probably 4.5 cash houses or 11 financed houses would cover my living expenses off of cashflow.  This is all assuming I manage them myself.  I could cover the 11 houses with current cash for down payments.  I could only by another 1.5 or 2 houses (on top of the one I have now) with my cash on hand.  If I stopped the business I could likely buy the 4.5 houses outright.

My more recent searches have led me to a community about 25 minutes away that is in a down market with limited job options and considerably lower housing prices.  More drugs and crime obviously also.  The houses have about halfed in price since 2008.  They could still get lower, though it seems hard to believe.  There has been some commercial reinvestment in the community in the last 2 years.  Depending on the exact area and the condition of these houses, they seem to be able to bring in 1.5% up to 2.3% of rental income per month from value.

Now, I could get loans for these, but they are almost too low of value to be worthwhile.  With a cash value for an about 2% property I estimate about a 16% cap rate.  I'd estimate needing about 6 of these to cover my living expenses currently.  If I cash out refi my current house I could buy these with cash on hand.  If (when) I shut down my business, based on this yield, I could have twice the income I need to live on.  This is also based on my managing these properties, which unless I moved to this area, might be tougher from 25 min away.  If I built these up while continuing to run my business, I may need to hire a manager.  If these continue to go down in value in the future, I'd need to use some of the cashflow to offset this.  If they go up, the return would be incredible.

I'm sorry for the quite long and probably even more confusing post here.  Basically, looking for advice on what others would do.  From what I've said here I know it looks like I could quit my job now and be covered depending on which option I choose.  I guess I'm not quite ready to close in my options that much depending on what happens politically or to me (girlfriend/family potential). 

Let me know what or any of this needs clarification.  I'm open to ideas outside of what I've mentioned here also.  Thanks, fizbanco 

[Kl285528]

Quick note because I'm on the run. Low income properties always have better cash flow ON PAPER. Make sure you understand the more intensive management required, likelihood of non payment, eviction and higher vacancy costs, greater frequency of repairs, getting sideways with the housing authority and code enforcement, greater likelihood of owning a crack house, house of ill repute, or having some one die on the property. Yes, I am speaking from experience on all of theses things.  Plus you mention being 25 minutes away, which makes the time load multiply exponentially.
Higher quality properties in better neighborhoods feature lower cash flow, but better prospects for long term appreciation, and on average easier management.
My advice... If you want to try one or two cheaper properties in the market that is 25 minutes away, then by all means try it out. Use that as an experiment to see how it goes. Just make sure the experiment doesn't sink the ship!

[fishnfool]

I have inlaws in a area like that who self manage their rentals. It's very hard to get good tenants, most who rent in those areas are there because of bad life choices, the rest either buy or move.

Good luck!

[srob]

I have some rentals in a great area, and then I have a building just a few miles away from the others that is in an ok area but the building is older and the units are smallish.

I manage the nicer area units myself and it is easy. I hired a management co to take care of the others in part bc there are way more issues to deal with. Late rent. Complaints about other tenants. Pets when against rules or being forced into emotional support animal situations more frequently (not all are bad of course, but not all of these requests that I get can possibly be for certified disabilities), we had a guy living in one of the basement storage units, using an extension cord from the laundry area. People have semi permanent live in friends in a 1 bdrm apt.  You get the idea. The property still does well, but there are increased expenses that need to be factored in with these kinds of properties.

I like kl28...'s advice. Try one or two rentals out if they are that cheap and see how you like it. If you decide that its not for you, no big loss.

[leighb]

I have a dozen units in a LCOL area. They were all bought under $30,000 and average rent is $500/unit. On paper one would think that they would cash flow like crazy. And some of them do, don't get me wrong. But every month one or two units are having a problem. Vacancies, evictions, bedbugs, behind on rent... and after a tenant moves out it can take a lot longer to turn the property. My experience with a security deposit is that typically tenants stop paying their last month's rent, rarely have I been able to use the security deposit for repairs.

Had I sold everything at the beginning of the year and invested in the stock market I would have made about the same amount with a lot less work and risk. But I like real estate.

What's nice about having a larger pool is that on average the properties are doing fine as a group. If I had a smaller pool to work with I would experience really great and really awful years. There's always a property or two struggling, the rest get to offset them which means that I can reasonably predict my income and expenses. On a bad month I am down 20% of my projected income (still cash flowing) which is better than being down 100% with no cash flow. It's easier for me to have a vacancy or problem when the rest of the units are rented and problem free.

As for what you should do? Hard to say. Starting small is wise but be prepared for the volatility of a less diverse portfolio. The lows can be very low. The most expensive turn I had after a tenant moved out was $11,000, (for just supplies) so have a good emergency fund.  It can be hard to sink money into a house and see it get destroyed. I use a property management service and have a handyman who usually spends 15 hrs/week keeping things from falling apart.

Good Luck

[KarefulKactus15]

@ leighb

You spoke of tenants often using the security deposit as last months rent.  A book I read on real estate  suggested making the security deposit higher than the rent so that doesnt happen.


I dont have any rentals yet, but from your perspective what flaws do you see in that theory?  Is that even legal? 

[arebelspy]

The houses have about halfed in price since 2008.

This is a huge red flag, to me.  Basically the country dropped from 08-12 or so, and then the last 4 years have come back.  Some areas above their peak, some still below, but the majority of areas have seen decent-sized gains since '12.

To have halved since 08 (and keep in mind, the worst areas of FL and NV cut about 60% peak to trough in 07-12) and not come back indicates to me the area is really bad.  Like, I can't imagine it not gaining since then in any way.  Even Metro Detroit, which I wouldn't touch, has seen large gains in the last two years.

To half since 08 and still be there today?  It may not kill it, but like I said... huge red flag.  I'd be looking into why that is.

I dont have any rentals yet, but from your perspective what flaws do you see in that theory?  Is that even legal?

Depends on your state laws.   You should read the landlord tenant laws for any state you're thinking of investing in.  Many allow 2-3x rent in security deposit.  Some have no cap at all.

[KarefulKactus15]

A quick glance suggest there is no cap in my state as long as its not applied in a discriminatory way, or some other way that attempts to circumvent the protections afforded to the tenant.

[NoNonsenseLandlord]

@ leighb

You spoke of tenants often using the security deposit as last months rent.  A book I read on real estate  suggested making the security deposit higher than the rent so that doesnt happen.


I dont have any rentals yet, but from your perspective what flaws do you see in that theory?  Is that even legal?

I am always a few hundred higher.  I have had some tenants question that, but good tenants do not even blink.  They know they get it back.  It is a great hurdle to weed out low quality tenants before you waste any time on them.

[leighb]

@ leighb

You spoke of tenants often using the security deposit as last months rent.  A book I read on real estate  suggested making the security deposit higher than the rent so that doesnt happen.


I dont have any rentals yet, but from your perspective what flaws do you see in that theory?  Is that even legal?

I am always a few hundred higher.  I have had some tenants question that, but good tenants do not even blink.  They know they get it back.  It is a great hurdle to weed out low quality tenants before you waste any time on them.

If the landlord charges more than an amount equal to rent for one (1) month, then the Ohio law requires the landlord to pay the tenant 5% per annum each year on the amount in excess of the monthly rental amount.

[clarkfan1979]

Not all tenants are renters because of poor life choices. Some of them make more money than me. Some early professionals don't want to buy a house because they are focused on their career and increasing their income. This often requires moving to different cities and different states.

I rent to college students. Some of them have parents that pay $30,000 out of state tuition and also bought them a $30,000 SUV for college. At least it's two years old, I guess.