If you’ve been reading my articles for any period of time, you’ll know that I am a big proponent of rental properties. They can provide cash flow and build wealth.
Over the years I’ve seen the good and bad of the rental business. The failures most often come when the investor gets into a property with unrealistic expectations.
When buying a rental property its important to go in with open eyes. As a rule of thumb, I divide residential areas into three categories in order to evaluate their characteristics and potential. Each category has its benefits and detriments. Depending on your goals, the characteristics can help guide your Real Estate investing.
Buy Cheap and Get DirtyCheap and Dirty Real Estate Investing
The first group of investments is both cheap and dirty (CD).
CD properties are located in areas where you probably do not live. The area can be characterized as somewhere between a war zone and a combat zone. The crime rate is higher than usual and drug activity is not uncommon. Most of the properties in these areas are tenant occupied.
Residents for these neighborhoods are a bit shaky. Collecting rent will likely be a chore each month. These tenants transition between jobs frequently. They will take less care in the upkeep of their homes and will contact the landlord for service more frequently. In addition, the cost of repairs when a tenant moves is often higher than those in non-CD properties.
For those willing to assume the tasks of aggressive rent collection and maintenance, cash flow in CD properties is incredible.
The initial investment into these types of properties is very low. In many markets, the expense will only be $10-20,000. If you plan to buy with cash, the returns are typically 20-30% if the tenant pays. CD properties are perfect candidates for Section-8 or other government subsidized housing plans. By utilizing this option, the cash flow is guaranteed.
Bread and Butter Real Estate InvestingBread and Butter is a Mixed Bag
My second group of rental investments is the bread and butter properties (BB).
BB properties are located in working class neighborhoods. They typically have 3 or 4 bedrooms and one to two bathrooms. Crime is usually limited to the out-of-hand party or the occasional domestic disturbance. Residences in these neighborhoods are mixed between owner occupied homes and rentals.
The BB tenant is a mixed bag. These residents usually have consistent, but lower paying jobs. It’s especially important to highly screen and scrutinize prospective renters to find the right match. I’ve had excellent tenants in my BB properties. They have always paid their rent on time, taken great care of the property, and stayed in the house for years. I’ve also had tenants that never paid a dime after moving in and trashed the house when they were evicted. Screening is always vital, but in BB neighborhoods it can be the difference between success and failure.
Investors willing to wait for a good deal will find one in the BB neighborhoods. Because the area has a large population of owner occupied properties, the deals are more difficult to find. Investors willing to wait for a good deal will find one in the BB neighborhoods. These properties have consistent appreciation and will yield some cash flow.
Snooty for the Long HaulReal Estate Investing in Snoty Neighborhoods
My last group I call the snooty properties.
Snooty properties are located in areas that are almost exclusively owner occupied. The areas likely resemble your neighborhood. Crime is lower than the region at large and properties are well maintained.
Tenants in snooty neighborhoods are typically professionals. They are often young or transient (i.e. an engineer just out of school or a college professor with an annually renewing contract). These residents typically pay on time and only call when there is a real problem. When they leave the property, you may have to paint.
The downside of the snooty property is two-fold. First, the properties often have a negative cash flow. This is often the reason that these tenants choose to rent instead of buy. It costs less. Second, the tenants want more. Snooty areas have nice properties with added amenities. These could include granite counter tops of hardwood floors. In order to attract renters it’s necessary to keep the unit trendy and up to date.
Snooty properties are where real wealth is nurtured and grown. Barring a cataclysmic financial event, there will always be professionals looking for housing. Each mortgage payment is an investment in the future (even if some of the cost comes out of your pocket). As houses increase in value, it’s the snooty areas that reap the majority of the benefits.
If you are pursuing rental properties as part of your Real Estate investing strategy, it is important to be informed about what you are getting into. Being educated and having a realistic expectation of the positives and negatives of the investment will help avoid many of the potential pitfalls.