Author Topic: Landlording In "Undesirable" Neighbourhoods  (Read 6792 times)

Mega

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Landlording In "Undesirable" Neighbourhoods
« on: August 09, 2013, 09:46:19 AM »
Hi There,

I am new to the Money Mustache world, but I have been growing one slowly without knowing it. My question today has to do with people's experiences landlording in undesirable neighbourhoods (specifically Hamilton Ontario).

My house (in neighboring Burlington) is worth approximately $400k, and can be rented out for somewhere around $2k/month. So houses in my area are clearly not worth purchasing to rent out. This is stupid valuation is quite consistent throughout all of the nearby cities in the GTA (Greater Toronto Area), except for Hamilton.

In Hamilton, there are currently a few houses on the market at ~95K, already rented out around ~$950 a month. These houses are in the undesirable downtown area (Think guys with basketball shirts and baggy pants, tattoos and walking pitbulls, with their pregnant girlfriend with roots showing on her platinum blond dye job). This gives a capitalization ration of 12% (Based on my reading here an elsewhere, this is a great return).

So, what are the pitfalls / cautionary tales about 'bad' neighborhoods?
What margin of safety do you look for if purchasing in such areas?
Why would anyone sell a currently rented property with a cap rate of 12%, unless there are significant problems with the building?
What tips do you have for someone thinking about starting out in the rental market? (I will have to convince my dear wife to buy the property)






mpbaker22

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #1 on: August 09, 2013, 09:55:48 AM »
How did you calculate the CAP rate?  It might be that you're over-estimating rents, remember to factor in tenants who don't pay and need to be evicted + vacancies.
You might be under-estimating expenses.  What if your less-desirable tenants trash the place and you have to do large repairs every 12 months?
What about insurance?  If there are a lot of problems in the area, insurance costs might be higher.

I could make a list 10 pages long, doesn't mean it's a good or bad deal though.  I'm in a similar situation, and I compromised by moving towards buying something in a less-than-perfect, but still desirable, neighborhood.

ArtieStrongestInTheWorld

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #2 on: August 09, 2013, 10:09:50 AM »
Also keep in mind that over time, repairs, vacancies, and other costs will typically eat up about 50% of your income from the property.  Given the information you've told us, you're likely to see at best a 6% return, which is not markedly better than what you could achieve through stocks.

What are the landlord tenant laws like in Ontario?  If they heavily favor tenants, you may want to consider that this could stretch out eviction times when you run into a tenant who doesn't pay rent.  I know here in DC, it can take landlords months to evict a tenant who stopped paying rent.

AlmostIndependent

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #3 on: August 09, 2013, 10:19:41 AM »
I've often wondered about this myself. I've often considered buying into some of the less desireable areas of my city but am unsure about the increased cost in things like vacancy rates, how many people don't pay, excessive repair cost, etc. I'm interested to hear other peoples experience.

tryan

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #4 on: August 09, 2013, 10:46:58 AM »
I've owned several properties in what most would call "undesirable".  Idea is to get LONG TERM tenants.  Working class can be very loyal and treat the house as there own.  Probably helps that I only do SF homes.  Longest tenant so far is 17 years.  Have 2 others at 13 and 15 years.

But I would not touch a 95k house that rents for 950/mo.  Think of 50k-60k at 950/month.  Else your busting your butt for nothing ... and negative most months.

honobob

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #5 on: August 09, 2013, 01:44:20 PM »


 

My house (in neighboring Burlington) is worth approximately $400k, and can be rented out for somewhere around $2k/month. So houses in my area are clearly not worth purchasing to rent out. This is stupid valuation is quite consistent throughout all of the nearby cities in the GTA (Greater Toronto Area), except for Hamilton.

 

1.  How did you jump to this conclusion?  Ask yourself, what was my property worth 10 years ago?  What would the rents be then? 
Compare that to the Hamilton property over the same 10 year period.  Then look forward 10 years and make a business forecast for rents and value.  Unless there is a strong possibility of gentrification in Hamilton you'll probably be way better off investing in Burlington.

honobob

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #6 on: August 09, 2013, 02:02:59 PM »
1.  You do not have enough financial information to compute a cap rate and even if you did WHAT WOULD IT MEAN?  The best you could say is that it has a gross rent multiplier of 8.33.  Is that good?  You'd have to compare it to similar properties in the area.  There is a reason the GRM is double in Burlington.  Find out why.

2.  Make sure you have good life insurance so your wife will be set if you have a problem collecting rents.

Another Reader

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #7 on: August 09, 2013, 02:24:58 PM »
Mega is taking the anticipated gross rent, multiplying it by 12 and dividing the result by the purchase price.  That's not the capitalization rate, that's the inverse of the gross rent multiplier.  The gross rent multiplier is 8.3, which is too high to attract my attention for that kind of neighborhood.  The overall expenses will likely be at least 50 percent, meaning the maximum capitalization rate is 6 percent.  Same result.

If you are going to work the marginal areas, you want two percent per month.  You are working for cash flow, not appreciation here.  Tryan does this and his numbers are right on.  One percent for newer houses in nice middle class neighborhoods is the minimum most people will accept for that type of property.  Less wear and tear, less vacancy, and a better shot at significant appreciation.

The one area I agree with Honobob is on the life insurance.  I'm not interested in war zones, and I would want my spouse to be well insured if he or she wanted to buy in one.

AlmostIndependent

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #8 on: August 09, 2013, 02:31:38 PM »
I have a friend who invests in rentals in some less desireable areas. He has a mailbox at a UPS store for rent collection. That won't help you with the people who don't pay but it does keep you from walking around the hood with a shit-ton of cash.

oldladystache

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #9 on: August 09, 2013, 06:01:27 PM »
I wouldn't do it but my brother has made it work for many years. He has properties in undesirable neighborhoods and rents them for significantly less than the market rate. He finds that people are so happy to have the low rents that they stay for almost forever, and pay the rent pretty much on time. When they finally do move there is usually a cousin or friend wanting to rent it as soon as they are out.

He does very little maintenance, and almost no cleaning up between tenants.

I understand he goes to the door and collects the rent in cash. As far as I know he's always gotten out safely.

Mega

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #10 on: August 09, 2013, 09:28:58 PM »
Also keep in mind that over time, repairs, vacancies, and other costs will typically eat up about 50% of your income from the property.  Given the information you've told us, you're likely to see at best a 6% return, which is not markedly better than what you could achieve through stocks.

What are the landlord tenant laws like in Ontario?  If they heavily favor tenants, you may want to consider that this could stretch out eviction times when you run into a tenant who doesn't pay rent.  I know here in DC, it can take landlords months to evict a tenant who stopped paying rent.

This is very useful information. I was not aware of the high 'maintenance' costs associated with rentals. And yes, the landlord law (Residential Tenancies Act) strongly favours the tenant. If I remember correctly, the tenant can delay eviction for non-payment of rent for like 3 months.

Mega is taking the anticipated gross rent, multiplying it by 12 and dividing the result by the purchase price.  That's not the capitalization rate, that's the inverse of the gross rent multiplier.  The gross rent multiplier is 8.3, which is too high to attract my attention for that kind of neighborhood.  The overall expenses will likely be at least 50 percent, meaning the maximum capitalization rate is 6 percent.  Same result.

If you are going to work the marginal areas, you want two percent per month.  You are working for cash flow, not appreciation here.  Tryan does this and his numbers are right on.  One percent for newer houses in nice middle class neighborhoods is the minimum most people will accept for that type of property.  Less wear and tear, less vacancy, and a better shot at significant appreciation.

The one area I agree with Honobob is on the life insurance.  I'm not interested in war zones, and I would want my spouse to be well insured if he or she wanted to buy in one.


Thank you for the clarification on the correct terminology. Based on a capitalization rate of ~6%, I would be better off buying a REIT yielding ~7%. As I said, I am a new Mustachian. Please note: Hamilton is by no means a warzone. Portions of it (the downtown mostly) are highly undesirable largely due to the proximity to the steel mills & other heavy industry. It is a far cry from Detroit.



 

My house (in neighboring Burlington) is worth approximately $400k, and can be rented out for somewhere around $2k/month. So houses in my area are clearly not worth purchasing to rent out. This is stupid valuation is quite consistent throughout all of the nearby cities in the GTA (Greater Toronto Area), except for Hamilton.

 

1.  How did you jump to this conclusion?  Ask yourself, what was my property worth 10 years ago?  What would the rents be then? 
Compare that to the Hamilton property over the same 10 year period.  Then look forward 10 years and make a business forecast for rents and value.  Unless there is a strong possibility of gentrification in Hamilton you'll probably be way better off investing in Burlington.

You make an excellent point. Not sure if you are from Canada/Ontario, but essentially house prices in the GTA are bat shit crazy (but not as crazy as in Vancouver). Think 2006 Las Vegas crazy (maybe not that bad, Florida might be a better comparison) Canadians barely dodged the housing price crash in 2007 (they did drop a bit), but prices have gone up by ~50% since then, without the required wage growth to support such prices.

For example, people are now asking $480k for houses with the same layout as mine. I paid $360K three years ago. A 10%/annum appreciation rate for a house is absolutely insane across an large region, unless there is some sort of resource boom (e.g. Alberta / North Dakota). I could rent my house out for around $2500, based on recent Craigslist postings. Looking at interest rates (3.29 - 6%) the mortgage would be between $1900 - $2500 @ 20% down. That does not leave very much for maintenance/vacancies/property taxes.
Note: In Canada, you are now required to put down a 20% down payment for a mortgage on a second property.

It is a sad world we live in where people buy a house based on the monthly mortgage payment, and not the total value of the house / interest rate risk.

Mega

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #11 on: August 09, 2013, 09:37:11 PM »
So, from the sounds of it, if renting in undesirable neighborhoods, the best approach is to obtain long term tenants.

In that regard, I see one option available:

Offer lower than market rates to make the location more desirable. Then screen applicants and hope for the best.

In regards to remaining safe when collecting rent, you can use a PO box for people to mail checks / be careful if dealing in cash.

Essentially, it mostly boils down to not being worth it.

Roses

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #12 on: August 10, 2013, 12:56:41 AM »
I've owned several properties in what most would call "undesirable".  Idea is to get LONG TERM tenants.  Working class can be very loyal and treat the house as there own.  Probably helps that I only do SF homes.  Longest tenant so far is 17 years.  Have 2 others at 13 and 15 years.

But I would not touch a 95k house that rents for 950/mo.  Think of 50k-60k at 950/month.  Else your busting your butt for nothing ... and negative most months.

Tryan - I'm curious about this (also a newbie).  If a 95K house is getting $950 a month, that meets the 1% rule.  If you're saying it should be a 50-60K house for that rent, that's almost 2%.  Based on the MMM article on this and some other reading I've done, I thought 1% was a reasonable rule of thumb.  Are you saying it's not sufficient?  Is it just because this is a less desirable area or do you recommend passing on any property that brings in less than 2% per month?  I realize there's more to it but I'm wondering about this particular 'rule'.  Thanks!

arebelspy

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #13 on: August 10, 2013, 07:44:31 AM »
1% is the minimum.*

I've never bought that low, and probably wouldn't.  That's the cut to start digging deeper.

I'd accept close to 1% if terms are good and it's in a good area.  In a mediocre area, I'd definitely shoot for closer to 2%.  I wouldn't buy in a bad area.


* You wouldn't just want the minimum, would you?  Look at Brian over there.  He's got a 17% cap rate, and a great smile to boot.
« Last Edit: August 10, 2013, 07:46:07 AM by arebelspy »
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honobob

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #14 on: August 10, 2013, 12:57:28 PM »

 
For example, people are now asking $480k for houses with the same layout as mine. I paid $360K three years ago. A 10%/annum appreciation rate for a house is absolutely insane across an large region, unless there is some sort of resource boom (e.g. Alberta / North Dakota).   

I think this is going over your head.  If you'd bought a house or two more in your neighborhood you'd be up $120,000 per house vs. a cash flow of maybe $100 a month in Hamilton ($120,000 vs. $3600). 

arebelspy

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #15 on: August 10, 2013, 04:38:41 PM »

 
For example, people are now asking $480k for houses with the same layout as mine. I paid $360K three years ago. A 10%/annum appreciation rate for a house is absolutely insane across an large region, unless there is some sort of resource boom (e.g. Alberta / North Dakota).   

I think this is going over your head.  If you'd bought a house or two more in your neighborhood you'd be up $120,000 per house vs. a cash flow of maybe $100 a month in Hamilton ($120,000 vs. $3600).

That's happened pretty much everywhere over the last year though.

My area is up 32.9% YOY (July 2012 to 2013).

If anything, the lower priced areas bounced up more because they had fallen farther.  We're still trying to get to a normal, healthy market.  One of the steps in this will be the pain when interest rates rise, and at that point I'd rather be shooting for cash flow than appreciation, but each investor must decide for themselves their motivation and targets in investing.
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sleepyguy

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Re: Landlording In "Undesirable" Neighbourhoods
« Reply #16 on: August 14, 2013, 11:57:53 AM »
Yeah Burlington is pretty insano... Oakville is even more hilarious (where I live)... we're in the smallest bungalow in the area... probably close to 600K if we sold today.

Hamilton mountain area is great but pricey.  I think the harsh areas would be too much of a headache and can you imagine having to go there at 3am to fix a broken pipe?

Another option is Mississauga condos... seems close enough to Toronto that renters wouldn't have an issue, and it's right on the GO transit line.  We are thinking of another condo (have one already in heart of Toronto).  Mississauga is quite a large city already with lots of work options so renters would not be an issue don't think.  I think some go for about $200k'ish...

Real estate in Toronto and GTA is nothing like some US cities for other posters... prices have barely fallen during the downturns.