New investors are often attracted to real estate by the idea of passive cash flow. There are so many programs, blogs, podcasts, and books out now that focus on the idea of passive cash flow and retiring early. This has caused a huge influx of people looking for the right engine to make their passive cash flow dreams come true. Real estate can be a great vehicle for passive cash flow but it’s important to remember that not all real estate investments are created equal, either in terms of return, risk, and time required.
It’s this desire for passive income that I find leads many new investors astray, especially investors from California investing out of state. When many new investors poke their head out into the world of real estate for the first time, they quickly discover that you can buy some houses for really cheap! Many new investors are drawn to the idea of cheap houses because the cashflow looks great on paper and they can buy a number of them. Instead of buying one $350,000.00 home, maybe they could buy 7 $50,000 homes instead! More doors equals more cashflow right? Unfortunately, these properties end up being a nightmare.
But first...What is a cheap home? The answer to this question depends on who’s answering but is often defined as sub-50k homes. This will obviously vary somewhat by market (Looking at you San Francisco and New York!) but in most major midwest or tertiary markets, this rule holds true.
Cheap houses often have a few common characteristics including
Tougher to finance - banks usually have a minimum loan amount
Higher turnover and turnover costs
Harder to resell
Located in declining areas
Higher CAPEX and maintenance as a portion of your cashflow - remember, a water heater in a 50k home costs the same as a water heater in a 350k home
The combination of these factors (or just one or two of them!) can severely impact your returns and can even cause you to have to come out of pocket for things like turnover, CAPEX, and repairs. If you find you’re spending more money overall keeping your rentals operating than you’re bringing in then you’re not really investing, you just have an expensive hobby.
If you are committed to owning your own rentals I would suggest looking for rental properties in areas within the “path of progress” in your given market. Look for gentrifying areas where young people are moving. These areas tend to have properties that are a bit more affordable and have tremendous upside potential. Often that upside can come quicker than you think. The combination of cashflow and appreciation in these areas will help to protect you from certain risks inherent in buying cheap properties.
If you are looking for a more passive investment, I would recommend looking into a syndicated real estate deal. In deals like this, your capital is pooled with others to buy a larger property. Returns are often in the 13-17% range annually and that’s without having to be hands on in the day to day operation of a property.
As always, feel free to reach out to us here at IronGall Investments with any questions! We’d love to hear from you!