Last week, Coaching Student Chris brought in a deal that he was pretty excited about.
It was a 3 family REO house in Meriden. Although it needs a lot of rehab, the price was low enough that he could acquire it with his self-directed IRA.
What about rehab?
He took about 100 pictures so that Coach Lou could advise him about the repairs.
When all is said and done, he is looking at $80k to $100k in work.
And Chris was still willing to do that. As his coaches, we thought he could find many other properties requiring a lot less rehab … less knowledge and smaller dollars required.
Still, rehab was do-able.
What about cash flow?
And then we looked at the potential cash flow. Since the property is vacant, he used www.RentOMeter.com to “guestimate” the potential rent. He was able to find out the property taxes and then estimated the other typical expenses: water, sewer, owner’s electric, landscaping, property management, vacancy rate.
Cash flow is looking good.
What about location?
Ah…. that is the issue.
Since Chris is not familiar with Meriden, he asked me if I knew anyone familiar with the area. Sure enough, one of my friends and CT REIA member has a building on that exact street… on the “good” end of the street.
And she said … this is a rough neighborhood where people come and go, and hang out on the corners. The location of Chris’ building is even worse.
Hint: Tenants are smart. They will live in the best possible neighborhood for their budget. If they hang up on you when you give the address, you know you are in the wrong neighborhood.
Chris was undeterred. After all, the price was right, the rehab was doable, and the cash flow looked strong.
We told him, “in this type of neighborhood, you will have high turnover”. With high turnover, comes high vacancy, lots of expense for turning over the apartment for the new tenant, and lots of phone calls for repairs.
All of a sudden, the income went down, and the expenses went up. Net result?
Cash flow decreases dramatically
Chris, being the optimist, was undeterred.
So finally, Coach Lou said:
“Do you want to babysit your building?
Because this is what it will take. You can expect to walk through your building once a day, get phone calls from your tenants, deal with contractors for turning over units, knocking on doors to collect rents.”
Do you want to babysit your building?
Since he has a young son, finally, Chris got the point. He could take the same $140,000 acquisition and rehab, and pour it into a building in a more desireable neighorhood.
Yes, he will be investing more per unit. However, he has the potential for having the same cash flow: lower vacancy, higher rents, and higher automatic payment of rent.
And NO BABYSITTING!
I watched Chris’ face … and saw the lightbulb go on. Having a son, he knows what babysitting is like and he did not want to do that for a building. After all, he is investing in apartments for passive income, for financial freedom, for appreciation and to be able to send his son to college.
Moral of this story
Location is all important. Don’t be enticed by high CAP rates without examining the REAL numbers. And talk to local people to get the “inside scoop” about the neighborhood.
Happy positive cash flow to you!
How about you? How do you evaluate where you are going to buy a building? How do you determine the real income and expense?