Photo:
Getty
I often discuss the importance of location when looking for real estate investments. For me, the ideal location refers to proximity to the city center and other areas ripe for gentrification. Often, investors shy away from buying real estate that’s located in neglected areas, also known as class C or D assets, even if those properties are right in the downtown core.
But shying away from these properties is a big mistake, especially for seasoned investors who may already have a good enough grasp on how to actively manage such properties. And considering the lower barrier to entry, newer investors should also consider this option, as long as they’re aware of requirements attached to ownership. Seasoned or new, you’ll have your work cut out for you; it’s not for the faint of heart.
One of my first purchases on a multiunit complex in a rough neighborhood, for example, involved working with the local police to remove drug dealers who had taken over the building to run their operations. All things considered, the numbers made it worthwhile.
Finding these hidden treasures is as easy as going onto Loopnet.com or Realtor.com, applying the appropriate filters such as city or state and sorting results by price from lowest to highest. Remember, you’re looking for the best price per room or unit, not per building.
Understand that, most of the time, you’ll find the most value for your money on a C/D-class property in a low- or no-income neighborhood. At this moment, for example, a quick search of Georgia suburbs on Loopnet returns the option of buying a 67-room hotel for $1.5 million in Americus, or a five-bedroom single-family home for the same price in Buckhead. From an investment perspective that is focusing strictly on cash flow, at a price of $22,400 per room versus $300,000 per room, the hotel is the best choice. With the hotel, after paying a sizable down payment, you’d likely see positive cash flow right off the bat. If each room is rented out at $50 per night — which is not a hard sell given that nightly rates in nearby franchise hotels are three times higher — then at 75% occupancy, you would gross approximately $1,125 per month on one room. It’s a disposition most helpful to new investors who need more room to grow their portfolio.
To be fair, I should stress that the initial search and purchase of a C/D-class property is the easiest part of the acquisition. Typically, these assets require a lot of renovations and ongoing maintenance compared to class A/B properties in the same area. Even then, spending $100,000 per year, for example, on renovations for a property that’s grossing approximately $1 million per year is very doable. The resplendent single-family home in Buckhead, on the other hand, will likely cost you $50,000 per year in mortgage payments and maintenance alone, all the while not producing any revenue, leaving you in a cash flow-negative position. It could be shared/rented out to one tenant, which would help alleviate some of the financial burden; however, the cash flow situation you’re in is still vastly different and, depending on your financial standing, potentially jarring. We can hope the loss would be made up by an equity gain, although this is not guaranteed.
Be prepared for the fact that the extra cash flow from a multiunit investment won’t be going straight into deeper pockets. As with any multiunit property, you’ll need to outsource the property management and security. Understanding the local culture is the key to success here. Outsource third parties that specialize in managing the same type of assets in the same type of area. If an online search for these companies is implausible, consult the building management staff of similar properties nearby. Pricing for property management would usually be around the range of 5% of gross rental revenue, likely higher for neglected areas.
Security can cost even more and is dependent on many factors, including the risk of legal fees and gaining a bad reputation. In my experience, it’s short-term pain for long-term gain (because much of the revenue you’d lose from unpaid rent, property damage, premises liability claims, losing loyal customers, etc.) is made back. In my experience, if you’re investing in a C/D-class hotel in a low- or no-income neighborhood, look to spend at least 10% of your gross sales revenue on security per year. Do not recruit internal staff, especially when it comes to security. Third-party companies carry their own general liability insurance, which comes in handy if you’re a property owner being sued for incidents that involved a security guard on duty. Also, many third-party security companies are started by former police officers who can do a better job of training and vetting new recruits.
If your investment is located in a high-crime area, consider hiring the local police during off-duty hours to supervise the premises. I’ve done this for multiple properties and found it to be an excellent deterrent. It proves, to both your clientele and local authorities, that you are serious about preventing crime. Ensure management knows the first and last name of the local staff sergeant for direct communication, should the need arise.
Remember, buying and maintaining C/D properties in low- or no-income neighborhoods is not for the meek. There are certain risks you have to be prepared for. By the same token, preparation is the key to avoiding those risks altogether. In my experience, if you’re willing to actively manage the property in conjunction with third-party help, the rewards will outweigh the risks. As a bonus, you will be adding a healthy balance and cash flow to your investment portfolio.