Cheap Rentals = Expensive Headaches
Note: All statements made in this article come from first hand experience in dealing with rental homes marketed at lower-than average rental rates
When looking to purchase investment homes in a major metropolis, what one notices quite quickly is the diversity of options they face. Homes can range from thousands, to hundreds of thousands of dollars. It is very tempting to inquire about a home with +20% ROI and an asking price of under $20,000. What’s there to lose?
If the home in question is expected to collect a bargain rental rate ($500-700), you might think that it’ll be easy to find a tenant. In reality, just because you’re offering the lowest rental price on the block, doesn’t necessarily mean that tenants will be lined up to call dibs. “Cheap Homes” are being sold across the country to investors looking to make quick money, but unfortunately, most of these purchases result in an endless pitfall of bills and profit loss.
Realistic expectations are always important. While the relative financial risk may seem reduced, past due bills, back-taxes, and chronic structural issues can hike up costs, and drastically reduce your expected ROI.
Less Money Now, More Money Later
Homes with low initial investments = simple deals …right?
You would assume that less money equals less liability and convolution in the process of home buying, but this isn’t always the case. Low priced homes might often be purchased through a “Quitclaim Deed” (QD) as opposed to a “Warranty Deed”. When homes are bought through QD, there are no guarantees on the title, or true ownership. Although it may only cost a few thousand dollars to get a handle on the title of the home, there is the possibility of liens on the property that could take months to clear, and thousands of dollars to satisfy. The 5-10 thousand dollar home in Detroit you hope to turn into a cash cow might not be ready for milking just yet.
Assuming that the title clears without incident, and the discounted rental home you’ve acquired is ready for cleanup, it’s going to take more than a single set of eyes to get the home move-in ready. One of the most important steps in preparing a home for a tenant is ensuring that all issues are addressed before the move in. Because cheap homes most often need repairs to be done before they can be considered “move-in ready”, the renovation budget should always be accounted for in the ROI. Uneven or swollen wood floors, stains on the ceilings, and unusual patterns in walls are telltale signs of hidden damage, which can pose a threat to your profits.
One factor that may drive a home price so low is a lack of recent updates, which often results in the need for (more than the usual) maintenance to remain habitable. Buying a bargain home is akin to buying a used vehicle with a plethora of warning lights in the dash—but homes do not have warning lights or whistles …a home cannot warn that the foundation is crumbling, or that the roof is a few rainstorms away from caving in.
Know Your Numbers
Inflated ROI calculations are based on a low initial investment, monthly rental payments, and overall appreciation value of the home. Unfortunately, home appreciation values aren’t always accurate, and monthly rental income might not be very secure if your tenants aren’t reliable.
Knowing what comes with the territory is important. Unstable neighborhoods are characterized by blight; many burn-downs, vacant/abandoned homes, and the absence of a “community feel”. Blight in a neighborhood will severely bring down the value of a home, regardless of its individual condition.
Once you are able to find a tenant to live in your bargain rental home, the gamble of monthly rental collection begins. In our experience, low-rent homes attract tenants with relatively unstable incomes. This may lead to a situation where a costly eviction, along with the absence of expected rent will drastically reduce profits.
Following the end of a tenant cycle in your rental home, many costs that may have not been accounted for during your initial ROI write up may arise. Repairs to get the home move-in ready again, agent listing fees, and other variables all are coming out of your pocket. On average, this process can range from 45-60 days, and cost $2,000. Keep in mind, of all the expenditures in renting out a cheap home, the most valuable is the time lost.
With no intent to prejudice against tenants living in low-priced rental homes, our experience has shown that it often leads to trouble. While it may seem harsh, this is the truth told through experience. Simply said, bargain rental homes will attract tenants that are looking for a short-term living situation, with oft-displayed disregard to any agreements made in the lease contract. If the idea of investing in rental homes attracts you, consulting with proven property investment companies will help to avoid profit dwindling deals. Keep your expectations realistic, and your investments logical.
If a deal seems too good to be true, it probably is!