Who doesn’t love scoring a great deal? While this approach works for the sale rack, it’s not so wise where rental properties are concerned. Real estate investors, from newbies to old pros, know the temptation of a “great” deal. We’ve been there, done that – and know from experience that cheap properties don’t build world-class portfolios.
In fact, they may pose more problems than they’re worth, even at a reduced price!
Because cheap properties are few and far between these days, we can’t blame anyone who wants to go after them. That said, there are some compelling reasons to set your sights a little higher.
Key Reasons Why Real Estate Investors Should Steer Clear of Cheap Properties
Reason #1: Low cost often comes with high risk
If it sounds too good to be true, it probably is. Properties with a low price tag are almost certainly hiding flaws. The price is reduced to compensate for the next owner’s repair costs. While you can understand present issues from a property inspection, some things can only be uncovered after the deal is sealed.
You don’t want to take that kind of risk unless you’re already planning for a total property rehab. Let’s be honest; most investors aren’t unless they’re in the flipping business.
Passive investors, beware of biting off more than you can chew. You’ll blow your profit margins astonishingly fast!
Reason #2: Those outdated features might be liabilities
An investor is well within their right to buy a low-value property, rehab it, and turn it into a premium home. Just remember the gap – and thus, the cost – is enormous. Even if you were to turn a property around from dump to divine, you must price it competitively for the area.
If a property is inexpensive, it is likely old and under-renovated. These are more likely to contain problems like asbestos and modern code violations. Older properties aren’t designed with energy efficiency and modern sensibilities in mind. This means that, oftentimes, a mere cosmetic overhaul won’t cut it.
Not only is this a headache and a half for the investor to rectify, but these necessary fixes aren’t going to be what brings in residents. You’ll contend with costs associated with safety and legality on top of aesthetic appeal.
Reason #3: Cheap properties earn cheap rent
Predictably, cheaper properties yield cheaper rental rates. Those lower rental rates mean gaining momentum with your passive income is harder. Making less each month on a property doesn’t necessarily change other costs, like management or maintenance. You want to maximize the value of your properties so you can charge a fair but premium price.
When the property you bought isn’t up to snuff, it costs more to justify a worthwhile rental rate. On the surface, it may make sense to go cheap because you can afford it. A smaller mortgage payment is attractive, especially in this economy. However, you’re not gaining any proportional advantage. The mortgage cost and the rental rate scale together.
This means you’re just earning less and limiting yourself to inexpensive rental properties. When your properties generate more income and have better appreciation potential, your wealth grows much faster.
Reason #4: Beware of turnover
The price point of your investment properties will attract and repel different types of residents. Lower-income residents aren’t bad per se. However, those with lower incomes tend to be less financially stable and more transient as they seek better opportunities for their families. For the investor, you want to target residents that will stay long-term. Safe, clean, desirable environments will do that. Cheap properties will not.
Throughout this post, we assume that the owner will do their best to renovate and maintain a cheap property to make it as attractive, livable, and valuable as possible. We also know that’s not always the case. When investors cut corners on the quality of their property, whether in rehab or ongoing maintenance, the residents are less incentivized to take care of their investment.
If you only focus on reducing costs, your long-term gains will suffer. Be willing to invest more money into quality properties and services. Your portfolio will thank you!
Reason #5: The location will also cost you
Location plays a notable role in the cost of a property. Prices may be lower because the area isn’t in a good school district, convenient or close to amenities, or is experiencing out-migration. Investors must target desirable areas. This helps shorten any vacancies while increasing retention.
Look at the comps in the neighborhood. Is your property the only one with a low value, or are they all like that? Beware of low-value areas. Not only can this limit your property values (as it’s unwise to over-renovate), but it can indicate trouble attracting and retaining residents.
With turnkey investing, you can bypass beginner blunders!