Welcome to Part 2 in this series for “Creating Multi-Generational Wealth and Financial Freedom.” I hope you enjoyed part 1 where I discussed the first 2 main ingredients for creating a successful recipe, Your Team and Cost of Living.
If you missed the first part, you can read and view it here:
Creating Multi-Generational Wealth and Financial Freedom – Part 1
For you, a property needs to cash flow NET positive.
“Net” is an important concept here. “Net” comes AFTER expenses. And poor quality neighborhoods usually mean poor quality (and very expensive) tenants and properties.
So you might be willing to sacrifice some cash flow, for a higher quality property and tenants…those who’ll stay longer and take better care of your property.
But if you go too far to the “quality” side, you end up with very expensive properties, which won’t cash flow unless they have very little, if any, financing.
Since leverage is one of the major benefits of real estate investing, it doesn’t make sense to buy properties whose cash flow can’t support financing.
On the other hand, if you go too far to the “high rents versus price of property” spectrum, you might end up with NEGATIVE cash flow because of high turnover, property damage, vacancy, bad debt, collections and eviction expenses.
So there’s an optimal range where quality and affordability mix to provide great investment value.
Of course, all things being equal, I like markets where the average property prices are low enough that I can buy more units. I’d rather have five $200,000 homes than one $1 million dollar home because I diversity my income over 5 tenants instead of just 1. And if I decide to move equity into a new market, or need to raise cash for some reason, I can sell 2 or 3 of the 5 and keep the rest.
Bigger picture, markets with more affordable price points compared to other parts of the country are more likely to continue to attract more demand. This puts upward pressure on both prices and rents, even if the overall economy is only doing so-so.
Age of Properties & Cost Per Square Foot
There are opportunities in any market, but to find what I consider the best recipe, the newer the property, the better. The reasons are probably obvious.
Older properties require more rehab and maintenance. Also, homes built in the 50’s and 60’s tend to be smaller than homes built in the 21st century.
While there’s often some charm in older properties, most tenants would prefer to live in something bigger, nicer and newer.
So while there are older markets with good economics and quality tenants, they aren’t my first choice. When comparing markets, my winning recipe calls for markets with newer properties and lower cost per square foot.
Simply put, I want a newer, bigger house for my money.
Market Hard Costs
There are certain fees and expenses you’ll have every year. Many of them are related to the market and sub-market you’re investing in. These items include taxes, insurance, homeowners association dues and the like.
Sometimes taxes can be lowered through a reassessment. But don’t assume so. Conversely, sometimes taxes will increase substantially with the new buyer (you).
The point is: be sure you know what the tax will be when you take over. And keep in mind that high property taxes aren’t necessarily a terrible thing if they don’t knock your operating cash flow into an unacceptable range.
If the local government is using those taxes to build quality schools, maintain parks, reduce crime (more on that later), and otherwise improve and maintain the local market, those taxes can be a good investment. After all, you can fix up your property. But you can’t fix up your market.
Insurance is another item that can be highly affected by the geography. These are things you might not think of if you’re out of the area. But don’t feel badly. Even the “big boys” get blindsided from time to time.
We were working with an Acquisitions Director for a major Real Estate Investment Trust (REIT) who purchased 20 homes through one of our teams. He was very happy with the acquisition and came back for more.
The AD told us he wanted 20 more homes in Houston and another 30 more in Dallas -Fort Worth. But when I sent him the inventory to underwrite, he passed on all the Houston homes!
He didn’t realize the insurance cost would be so much higher in Houston than in DFW because of the weather. When he ran the portfolio through his model, the high cost of insurance took it out of his range and rejected the deal. But he had no idea going in.
So the lesson is to make sure you check your local market expenses carefully because all markets are not the same. Be aware that formulas based on national averages or your personal experience in a different market may not anticipate some unique expense for the market you’re actually shopping in.
Another important lesson: Just because the big guys are doing something doesn’t mean you should just follow along blindly. Sometimes even the big money managers make mistakes or get in over their head. ALWAYS do your OWN homework. If you get a major component of cost wrong, it could blow up your numbers…and your balance sheet.
Be on the look out for part 3 in this series where I will discuss the consideration of Crime & Safety, Job Growth, How to Spicy Things Up and Demographics. You won’t want to miss it!
Watch the video below for a recap of Part 2!
Talk to you soon!