Some Deals Aren’t As Good As They Seem
Posted on December 22, 2006
Two of the biggest mistakes new investors make are buying upscale properties that seem to be great deals or buying bargain properties in low rent areas. The most consistently successful investors buy properties that will rent in the middle 40-60 percent range for a given market. Properties that rent in the top or bottom 20-30 percent range are usually laced with problems that many new investors fail to discover until it’s too late. Let’s look at these properties separately.
You can always find what seem to be good deals on properties in upscale areas. There are people trying to climb the social ladder who buy in these areas before they can actually afford it. As a result some of them get in over their heads financially and have to sell at a deep discount to get out from under the payments. To a new investor, a $600,000 property that can be bought for $450,000 to $500,000 seems like a great deal, and it may be if they plan to live in the property. However, properties like this don’t make good rentals, especially in markets where mid range rentals may sell for $100,000 to $200,000.
These upscale properties typically attract one of four types of renters. The first are people new to the area who want to rent temporarily while they decide on the area of town in which they want to buy. Second are people who have sold their home and need to rent while they are waiting for construction to be completed on a new home. Third are people who have the ability to earn a high income, but a financial setback has damaged their credit to the point they re temporarily unable to buy. And fourth are executives who have been transferred to the area by employers and don’t plan to keep them in the area long term.
None of these groups makes for stable tenants, and when a property goes vacant, finding another tenant can be time consuming and expensive. Although bread-and-butter mid-range rentals may not be the kind of properties you would want to live in, they do attract good tenants who stay longer, make them a home, are proud to live in them and take better care of them.
In addition to this caution about deals you can find on upscale properties, I also urge you to be extra careful with deals you find in bad neighborhoods. While some properties can be bought dirt cheap, they are often loaded with unseen problems. An easy test is to ask yourself if you would feel comfortable walking the neighborhood alone and chatting with the people who live there. (Of course I’m talking about during daylight hours.) If not, unless you plan to buy the whole neighborhood and rehab it to attract better tenants, you’re better off looking elsewhere. Many of the tenants that are attracted to low rent properties often bring problems that go far beyond just being poor renters. Drugs, prostitution and other vices tend be more prevalent in low rent areas and higher crime rates are likely to follow them. Rent is more difficult to collect from people with low incomes and maintenance costs can soar.
A general rule of thumb is to use extra caution when prospective properties seem to be super bargains. There is usually something, often something hidden, that makes the deals so good. In many cases, the seller may be like the rat when it thinks, “To heck with the cheese, just let me out of this trap.”
High vacancies are the biggest problem with upscale properties, while past due rents and high maintenance expenses have a tendency to be more prevalent in low end properties. Properties that rent for $3,000 to $4,000 per month may sit vacant for months between tenants in markets where the mid range of rents runs $1,000 to $1,500 per month. There simple aren’t that many people who can afford them.
Cheap rentals are easier to keep rented, but the tenants they attract are lower wage earners or ones relying on some form of public assistance. Many of them have less than desirable credit, little pride in keeping a landlord’s property clean and neat and in general cause more damage that has to be repaired before the units can be re-rented. These neighborhoods also attract people with addiction problems who are looking for cheap rentals so they will have more to spend on drugs, alcohol or other vices. Granted, there are good people who simply can’t afford mid-priced rentals, but unfortunately the cheaper the rent the fewer of them you find.
Here’s a tip! If you want to become a successful real estate investor, be patient, learn about your market and carefully evaluate each prospective purchase. When a deal seems too good to be true, that should throw up a red flag. Focus on trying to find the hidden problem that makes is such a good deal. This applies not just to upscale and cheap properties, but to any exceptionally attractive deal. There could be structural problems, deficiencies in infrastructure, undesirable development on the horizon or other problems not readily apparent. There’s an inspection form on my website that will help you locate most structural or deferred maintenance problems. You can download it FREE at http://weekendmillionaire.com/Inspection_Form.pdf
There’s no doubt you can be successful if you follow this simple advice: Investigate before you invest. I’ve never heard of anyone losing money on properties they didn’t buy.
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