7 things to consider when accumulating cheap rental property!
Here are 7 things to consider when accumulating "cheap" rental property:
1. Where to buy?
The largest price declines are in neighborhoods that have high concentrations of homes that were bought speculatively over the last 5 years. These areas typically have many foreclosures which have driven values down. These areas usually have many rentals and vacant properties. The trick is to buy on the fringes of these areas in the nicer neighborhoods where the banks fail to differentiate between the good and the bad. You want to find the heavily discounted home in a neighborhood that has a lower rate of foreclosure, fewer vacants and few rental properties. These areas will recover first and where the values are now gives you a glimpse as to what your downside risk is in event of another housing recession. If you buy a home for $20k in a neighborhood where you have 5 to choose from at this price, your investment could be worth $20k again one day.
2. What will make your property rent in good and bad markets?
We have learned this lesson the hard way. Renters want what you want in a property and this can't be overlooked because you are only paying $20k for the home. Renters want the following in areas where homes are cheapest: Easy access to public transportation, reasonably close shopping and most importantly - at least 3 bedrooms and 2 bathrooms. We have over 35 rentals and our 2 bath homes rent 5 times faster than our properties with 1 or 1.5 bathrooms. A 2 bedroom home is a killer to rent and it rarely rents for enough in these areas to be worth owning.
Another important consideration is the "family friendly" aspects of the property. If the property has 4 bedrooms than the backyard and surroundings had better appeal to a renter with children. Is the yard flat or fenced. Is the home on a busy road? A 2 bedroom home will not have family appeal so it's backyard and surroundings aren't as important. If you buy a 2 bedroom home it had better be a steal and in an area that is highly desirable.
3. What will give me the highest rate of return?
In areas most affected by foreclosure there are usually government agencies providing housing assistance to renters in these areas. Most of these "housing authorities/agencies" base the assistance they will provide on the number of bedrooms the home has. In Atlanta, GA the rent is approximately $750 for a 2 bedroom, $950 for a 3 bedroom and $1150 for a 4 bedroom. Clearly, you want only 4 bedroom homes in your inventory. They rent more easily and they rent for the most money.
Another consideration that affects your return on investment is the property taxes of the property. Many homes in these speculative areas were involved in fraudulent transactions and are assessed for 10 times there current value. We purchased a home last year for $35k that had been previously purchased for $220k. The taxes on this property equal 2/3 of the rent we collect. Not good. We are in the process of having the county re-assess the property but we have over-spent $4000 on taxes that we won't likely recoup.
4. How should I take ownership of these homes to maximize the number of rentals I can accumulate?
My wife and I took ownership of our rentals each individually because when we accumulated our properties there was an underwriting guideline that you could only have mortgages on 10 properties in your name. So I have 10 homes with mortgages and my wife has 10 with mortgages. Had we taken ownership as Kurt and Sheila Johnson we would have been capped at 10 total. I read on Active Rain that this guideline is going back to 10 properties from 4 effective March 2009.
There are probably many postings on Active Rain that detail methods of moving your properties into LLCs and Trusts but I have been reluctant to do this for fear that our lenders would want to retrieve their money on these loans because of the "Due on Sale" provision in most loans. Most of our properties are at a fixed rate of 6.5% and when rates return to 10% they might come asking for their money back.
We protect our properties with abundant individual insurance policies and an umbrella policy.
5. Should I consider condos or homes with monthly dues?
We would strongly discourage you from buying condos or homes with monthly dues, particularly ones that are "cheap" because of frequent foreclosures in the complex. Our experience has been that homes in these complexes suffer the highest rate of deflation in downturns and appreciate the least in up turns. These properties in high foreclosure areas also suffer because frequently the HOA struggles to collect fees from all of the unit owners. This results in increased fees and in some instances bankruptcy for the HOA which kills the ability for a buyer to get a loan on your property when it comes time to sell.
6. Where they are located is important when you have numerous rentals!
Because we bought most of our rentals at foreclosure in one county, our rentals are almost all within 15 minutes of each other. This is very helpful when doing preventative maintenance or when you get several simultaneous service calls. My handy man can deal with problems at 4 properties in a day because of their proximity to each other. The risk to this is the lack of diversification. Because so many of our homes are in the City of Atlanta, we would be devastated financially if the City schools lost their accredidation or some other negative event occured.
7. Can you imagine the house ever selling to a retail customer?
Some of the best deals are in areas where retail buyers haven't bought in 10 years and there is little hope for prosperity in 20 more years. CASHFLOW is not enough to make a property a good investment. Appreciation should be the determining factor on the purchase of a rental, not cashflow. A rental that nets you $400/month for 60 months is nothing compared to a great home that nets $0 but appreciates 40% in 60 months. Because of the depressed values we are experiencing, it is easy to find a good deal on a retail friendly home that could appreciate over 100% in 60 months. Atlanta is full of junkers for $24k that may never have retail appeal but there are plenty of "good" areas in Atlanta with 4 bedroom 2 bath homes for $45k that will see $140k again in 5 years. Homes that have no retail appeal have to be sold on a "wholesale basis" to other investors who will be evaluating the property only on a "cashflow basis". The widest margins are achieved when making the sale to a retail buyer on an "emotional basis".
If you are a Buyer looking for properties in Atlanta and surrounding counties, please consider enlisting the help of Kurt and Sheila Johnson in your search. Because the Seller always pays our fee, our experience costs you nothing. kurtandsheila@kurtandsheila.com