Investment property - too good to be true?

[Johnny Aloha]

Aloha everyone! 

I'm looking purchase some rental property and have been browsing Bigger Pockets.  Recently came across this post: http://www.biggerpockets.com/forums/517/topics/85027-columbus-cash-flow-duplex

It seems too good to be true.  Am I missing something?  And as a side question, I'm wondering if anyone uses bigger pockets to find possible deals.

In summary:
Asking price $34.5k (+$1500 for closing costs) = $36k
Gross rents $1100/m = $13.2k/yr

Annual Expenses:
$1294 Property Tax
$1300 Property Management
$900 Insurance/year estimate

Estimated annual expenses:
$650 vacancy (5%)
$2000 maintenance

Cash flow = $7056

Cap rate = $7056/$36000 = 19%

[marty998]

I cannot for the life of me understand your property market. Having said that, none of you seem to understand ours, where we actually put a reasonable value on a roof over our heads.

You can't have a shit price and high rent/yield. It's called a free lunch and it doesn't exist or it means your asset is priced for armageddon.

In your case prices should rise or rents should fall. Since neither is happening, I can only conclude that the basic economic supply and demand theory is broken or it does not apply to the US housing market.

Either that or you take advantage of the longest running arbitrage opportunity in history. Your call.

[boy_bye]

I cannot for the life of me understand your property market. Having said that, none of you seem to understand ours, where we actually put a reasonable value on a roof over our heads.

You can't have a shit price and high rent/yield. It's called a free lunch and it doesn't exist or it means your asset is priced for armageddon.

In your case prices should rise or rents should fall. Since neither is happening, I can only conclude that the basic economic supply and demand theory is broken or it does not apply to the US housing market.

Either that or you take advantage of the longest running arbitrage opportunity in history. Your call.

Did you miss the part about it being a duplex? $550/month for half a duplex is a reasonable rent. And, especially in lower income neighborhoods, you can often find 15-20% returns. In fact, that's the rate of return we expect an investor buying our place to get, and we're selling for approximately 18k. I don't understand what is making you upset about this. Do they not have lower-income neighborhoods in Australia?

All that being said, OP, what kind of condition is the place in? That would be my major concern, as well as finding responsible tenants in a low income neighborhood. You could easily eat up all that profit with one roof replacement, or one bad tenant you can't get out.

What are the tenant/landlord laws like in Ohio? That would be another thing to check out -- some states it's easy to get bad tenants out, and some states it's much more difficult.

And what's the neighborhood like where this building is? Is it just working-class/modest, or is it a full-on war zone? Would you be near the university and renting to college kids? Are buildings in the neighborhood selling quickly, or do they sit on the market for a long time? Do you have an exit strategy?

Finally, do you live in the area or will you need a property manager? Some PMs won't work in bad neighborhoods, so that might be worth checking into as well. The higher rate of return in low income areas is usually earned through the hassle and time involved in dealing with lower income residents.

Go on Bigger Pockets and search for "ghetto" and read the first few forum posts that show up. There are some very realistic tales there on what it's like to be a landlord in to low income neighborhood, at least check them out as you do your research.

[arebelspy]

If it seems too good to be true...

Agreed with madgey- it's very likely in a low income area, meaning your vacancy rates will be much higher than 5% (which is often optimistic even in a nice area), and repairs much more.  Also many more expenses (higher repairs when tenants trash the place, turn it into a meth lab, etc.) and credit loss (I.e. them not paying) and legal (evictions).

Search "war zone" on BiggerPockets.

Yields of 15-20% aren't uncommon in areas like this, the problem is collecting rent and making it happen.  You need to be an "enforcer" type landlord with a strong backbone to deal with those tenants. And if it's a long distance landlording thing, that type of investing is almost impossible, as you won't find property managers who will deal with those types of properties.  Or, if they do, they won't bother much, because they know you have no alternative.

Ask yourself why no one else is snatching that up.

All that being said, if you are local, do want to deal with the many headaches that come with those type of properties, you very likely can get 15-20% returns.  They do exist. Yet most stay away, for good reason (or start out there, and quickly regret it).

Essentially the reason why they pay such good returns is twofold - a lot higher risk, and lack of competition due to the extra work, stress, and headaches they provide.  They HAVE to provide higher returns to compensate for all of that.  If people wanted them, prices would rise, and yield would drop.  No one wants = low cost = high yield.

Bottom line: if it seems to good to be true, there's a catch.  That's the catch with these type of properties.  They can produce fantastic cash on cash returns.  You have to decide if it's worth it.

I personally like 10-12% in a middle class working neighborhood with no hassles than 16-18% in a war zone.

Best of luck, and let us know how it turns out!

[AlexK]

I have a property which yields 26% on paper with property management. In reality it yielded 9% last year. It's amazing how hard tenants can be on things and how easily property managers spend money that isn't theirs. 

[babysteps]

Apologies, this post got long.

My $0.02: the higher potential yield may not be worth it if you are trying to manage a property from afar.  (rare) Exception: if you can have enough properties in a single area to make yourself 'important' to a good property manager, it could work out.

+1 on war zone concerns & managing from afar - in our area, different cities vary greatly on rental regulations (the city where we have been most active requires out-of-county owners to hire an in-county manager - luckily we live in-county).  Neighborhoods (safety and property conditions) can shift dramatically in just a block or two.

I think those numbers could be real, they are similar to what we see in southern tier of NY state.  Partly the low-end market gets skewed because most banks won't lend on small $ properties unless they already have a strong relationship with the borrower, so it becomes an all-cash market.  Partly, every so often you get a tenant who will completely trash a home, and overall market yields reflect that.  Dynamic here is that our housing stock was created when population was much higher, but current unemployment is not bad (close to national average), so rental prices aren't nearly as depressed as home values are.


(more details follow...feel free to stop reading here!)

When I do my own analysis, I usually use a 10% vacancy allowance.  I also reduce the rent by 10% from "market", in theory to get a better pick of renters.  (It's not so much that you will see 10% vacancy, but it in my experience this works out closer than a 5% assumption to the actual costs for renewing the unit when someone leaves.) 
Full disclosure part 1: we (me & the spouse) no longer do much straight rental, instead we do rent-to-own or sell with owner financing.  Less hassle, but being local may matter more. 
Full disclosure part 2: I used to be a financial analyst, so I torture/play with the numbers more than necessary.

One other way to get involved in such a distant market would be to lend money to investors in such markets (you make a secured mortgage to them), or buying notes that such investors have made if they are doing seller financing.  Much less hassle from afar, but your yields are unlikely to top 11-14% in my experience and you may want to use a local servicer. 
Full disclosure part 3: we have sold seller-financed mortgages to investors, so I might be biased!

Not sure if any of the peer lending sites have such borrowers (I haven't looked), but that way you could diversify your risk among multiple cities/borrowers/etc.  There are also sites that re-sell notes whole (you trade a bit lower yield & more concentration for having someone do at least some due diligence for you).  Also regulations vary by state for secured lending, lawyers may be required if doing this direct (not through a sponsoring site/company).  [I am not a lawyer; all our activity has been in-state and with both sides using lawyers].

There are lots of ways to manage risk for the note buyer (discount to note face value, sinking funds, seasoning, etc etc) - putting the terms together is as much a structure/numbers thing as a real estate thing.

[Johnny Aloha]

Thanks for all the comments and advice. 

This would be a long distance investment, and I was tempted by the subject line, but not sure it will work. 

I always ask myself: if it's this good of a deal, why hasn't anyone else bought it yet? 

The search for rental property continues ...

[arebelspy]

Probably for the best.  Don't give up though, there are lots of good out of state investments; I'm planning on making some more myself soon.

If I may offer a suggestion (feel free to ignore): I might approach it differently than you are.  Rather than just looking for a "deal" and not caring where exactly it is, start to research areas that you would like to invest in.

Look into trends in the area: employment, demographics, population growth, etc. and well as (obviously) price to rent ratios, vacancy rates, etc.

Once you have targeted a specific area or two, then I'd start familiarizing myself with the local market in terms of neighborhoods, etc.

Then you'll be at the deal searching phase.

(Of course, I may be mistaken, and you chose Columbus specifically and are looking for deals in that area, and if so, my apologies, and hopefully this will be helpful to someone else).

[marty998]

OP...I just realised the significance of your name....Johnny Aloha from the MMM Hawaii trip?

I'd take a 19% return, but I'd make sure I get the best Landlord insurance I could find that would cover everything from tenant damage to missed rent. Sounds like a bargain to me, evidently not for most people here (which is what I thought may happen).

Don't want to hijack the thread but I have to respond to the below..

I cannot for the life of me understand your property market. Having said that, none of you seem to understand ours, where we actually put a reasonable value on a roof over our heads.

You can't have a shit price and high rent/yield. It's called a free lunch and it doesn't exist or it means your asset is priced for armageddon.

In your case prices should rise or rents should fall. Since neither is happening, I can only conclude that the basic economic supply and demand theory is broken or it does not apply to the US housing market.

Either that or you take advantage of the longest running arbitrage opportunity in history. Your call.

Did you miss the part about it being a duplex? $550/month for half a duplex is a reasonable rent. And, especially in lower income neighborhoods, you can often find 15-20% returns. In fact, that's the rate of return we expect an investor buying our place to get, and we're selling for approximately 18k. I don't understand what is making you upset about this. Do they not have lower-income neighborhoods in Australia?

Didn't mean to sound agitated, though I can see how that came across :) I'm more astounded at the numbers. Lemme put it this way..if I were a prospective tenant, would I pay $13.2k a year to rent, or would I save for 2 and a bit years and buy it outright for $36k? To me, in that situation, nobody has an excuse to be a tenant.

I suppose I'm astounded more than anything else. You'd be very hard pressed to find a similar property in an Australian metro area (certainly not East or West coast) for less than $200k. And that is considering the low income areas. Houses in low income areas go for $300k, except for maybe Adelaide and Hobart. But Sydney, Melbourne, Brisbane, Perth and Darwin you're looking at 400k, perhaps 500k minimum

Kinda difficult for me to understand how a house can be valued less than a car, even if the option is a pool of ratbag tenants.

[Another Reader]

The 19 percent is pro forma.  You would have to be be very lucky or very persistent in your management to get half that. 

[DoubleDown]

if I were a prospective tenant, would I pay $13.2k a year to rent, or would I save for 2 and a bit years and buy it outright for $36k? To me, in that situation, nobody has an excuse to be a tenant.

I agree with you, and I think you have the answer right there in your statement above: the ability or discipline to save seems to be absent for so many people. Notwithstanding other possible benefits of renting vs. buying, they pay rent in excess of what a mortgage would cost, year after year, even in areas where buying a house costs less than a car. Banks in the U.S. have made it much tougher to buy, too. It has been very difficult for people to secure financing to purchase a house without immaculate credit, lots of money for a down payment, excellent and stable income history, and no other significant debt.

[boy_bye]

if I were a prospective tenant, would I pay $13.2k a year to rent, or would I save for 2 and a bit years and buy it outright for $36k? To me, in that situation, nobody has an excuse to be a tenant.

I agree with you, and I think you have the answer right there in your statement above: the ability or discipline to save seems to be absent for so many people. Notwithstanding other possible benefits of renting vs. buying, they pay rent in excess of what a mortgage would cost, year after year, even in areas where buying a house costs less than a car. Banks in the U.S. have made it much tougher to buy, too. It has been very difficult for people to secure financing to purchase a house without immaculate credit, lots of money for a down payment, excellent and stable income history, and no other significant debt.

yes, and many of the people in the neighborhoods where you can buy a house for $20K are also spending $70 a month on their refrigerator, $60 a month on a stereo, etc. the concept of saving up and buying something for cash is pretty foreign in low income neighborhoods. (i say this as a person who at age 8 had the calculator out to show my dad how stupid it was to get anything at rent-a-center.)

[Johnny Aloha]

@marty998: yes, I'm the guy from MMM's adventure in Hawaii.

@arebelspy: Good idea to focus on a geographic area instead of high returns. 

Thanks for the advice everyone.  I'm also amazed that a property priced this low will rent for $1100/m, but I guess that's not uncommon in the US housing market now.

[kendallf]

A friend of mine and I both bought low priced houses within the last year.  He paid $21k and his neighborhood looks like the scene of a crack dealer episode of 'Cops'.  Despite this, rents there are apparently in the $900-1100/mo range, mostly courtesy of HUD.  I think he's over-fixing his house; he has around $50k in it now, mostly due to outsourcing a lot of the renovations, and I expect the tenants he's likely to attract will not maintain the interior that he's painstakingly restoring.  I joke that he has the nicest crack house I've ever seen..

I bought one for $35k in a better neighborhood, still 65 yr old small houses in mixed states of repair.  We're planning to move into this house later this year.  Rents in this area are less, rather weirdly -- maybe less HUD pricing?  Going rate seems to be $700ish for a ~1000 sq foot house, no garage.

There's money to be made, for sure -- but the headaches are very real as well.  I met a couple who have 5 or 6 houses around mine; they bought several at prices from $17k to mid 30s, fixed them up, and are doing well.  Both still have day jobs and they are working on one of the houses almost every weekend.

[illy5603]

There are a lot of things to consider when investing in property that you live far away from and will not be managing. As has already been pointed out, watch out for the warzones. In my case, I bought in Memphis and the houses that looked awesome on paper, mostly duplexes, were real red flags when I walked through them. Old English bottles in the grass, piles of old tires on the neighbors front yard, etc. Long story short, I ended up buying one of the more expensive properties in a better neighborhood, actually I bought two. Even there I ran into a snag... The one I vetted with a walkthrough and saw at the end of being rehabbed is my ace! Good tenants, no vacancy and minimal repairs. The one I bought after driving by but not walking through however ended up needing additional repairs and had a 3 month vacancy within the first 6 months of owning it. Never buy a property you don't inspect IN PERSON!
 
So my advice? Yes the math has to be there, but you would be wise to visit any property you intend to purchase. I am also grateful that I had a friend that was already buying in the area and I got to look over his numbers. Mine have no been very similar, some even better, and am very happy with my decision.