When it comes to evaluating cash flow real estate investment opportunities, investors must look beyond the surface. We’ve all heard the famous words of real estate, "location, location, location." It should be no surprise then, that location can make a huge difference in the quality of an investment opportunity, even within a particular city. It is amazing how many real estate investors overlook the "location" factor, though, when it comes to cash flow properties. Many investors simply look at the top line numbers (price and rent), and stop there—a costly mistake. In this article we will explore how location can impact the bottom line for real estate investments—in ways you might not have thought about.
The first problem with low quality locations are that vacancy rates tend to be much worse than their high quality counterparts. Typically poor quality locations (or zones) are home to lower income families. These lower income families tend to spend a large portion of their monthly income on housing, which leads to a higher risk of default. In addition, jobs in the lower wage tier have much higher turnover and layoffs than the upper tier. Since these low income families don’t tend to have much in the way of savings, any job instability brings with it a huge chance of default.
Low quality zones tend to have high crime rates. As a property owner in a high crime area, not only will you be subject to potential police inquiries and other headaches, but you will also likely be saddled with higher insurance premiums—which can take a bite out of your bottom line.
Poor Quality Tenants
Low quality neighborhoods attract low quality tenants. If you have ever been a landlord before, you will understand that getting stuck with a bad tenant can be an incredibly costly endeavor. Bad tenants not only cause you to lose sleep, but can also destroy your investment. These tenants are likely to leave your property in poor shape upon their departure (many times on unfriendly terms), costing you a considerable amount of money to repair, in order to get the property ready for the next tenant. If you have a property manager, you will also be stuck with a large marketing fee as well for placing a new tenant —one who might end up being just as bad as the last.
Bad Property Management
Having a good property manager can make your life easy as a real estate investor, but unfortunately many of the good property managers won’t work in these low quality location. That means there is a higher chance that the property manager you end up with is not very good. While a good property manager can make your life easier, it should also be said that a bad property manager can be worse than having no property manager at all—as you are essentially paying them for nothing. A bad property manager will lead to higher vacancy rates, low quality tenants, more defaults, and the list goes on.
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To get an idea of how these things can impact your real estate investment, let’s compare an investment opportunity in a high quality location, to one in a poor quality location.
item | Good Cashflow zone | POOR CASHFLOW ZONE |
PURCHASE PRICE | $ 50,500 | $ 50,500 |
CLOSING COST 1 | $ 1,900 | $ 1,900 |
INVESTMENT | $ 52,400 | $ 52,400 |
RENT (Monthly) | $ 825 | $ 825 |
MONTHLY EXPENSES | ||
HOME OWNER’S INSURANCE 1 | $ 38 | $ 76 |
PROPERTY TAX 1 | $ 49 | $ 49 |
PROPERTY MANAGEMENT | $ 50 | $ 50 |
VACANCY PROVISION 2 | $ 50 | $ 149 |
MAINTENANCE PROVISION 2 | $ 50 | $ 149 |
Subtotal | $ 236 | $ 472 |
TENANT MARKETING (AT LEAST ONCE) | $ 0 | $ 825 |
ANNUAL RETURN | 13.49% | 6.51% |
Note: Estimates are indicative; subject to variation on actual properties and location. 1 Sourced from Closing.com/Zillow. 2 Assumes 6% Vacancy Provision and 6% Maintenance Provision (per HomeUnion standards). | ||
As you can see, even though the top line numbers are the same, the underlying impact of owning a property in a poor location can have a dramatic impact on the ultimate profitability of your investment. In addition to these factors mentioned above, higher quality neighborhoods also tend to appreciate at a much higher rate than lower quality neighborhoods.
As a cash flow real estate investor it can be incredibly tempting to move on a property with juicy top line numbers—don’t fall into the trap. Before you move on any investment property you must make sure that the property’s location won’t leave you stuck with a load of unexpected expenses. Remember, when an investment opportunity appears to be too good to be true, it usually is. If you are unfamiliar with the area, make sure to seek the advice of a couple real estate professionals in the area—along with performing onsite due diligence yourself—to ensure you are buying a cash cow, and not a money pit.
This is the fourth article in our series on critical mistakes real estate investors make. Make sure to check out the first three articles:
"Single Family Real Estate Investment"
"Investing In Real Estate Doesn’t Have To Be A Local Endeavor"
"Real Estate Investment Companies: Don’t Be Fooled By Their Bloated Return Claims"
Also keep an eye out for our fifth article in the series next month. If you want to get a sneak peek, we’ve made our full report on the critical mistakes real estate investors make, available for instant download on our website. If you would like to receive a copy of our free report, you can download one here.
HomeUnion Services is a unique real estate investment platform providing high income single-family cash flow homes nationally for real estate investors. HomeUnion finds Cash Flow Zones with favorable rental to home price ratios, stable employment and strong rental culture. HomeUnion offers these properties fully tenanted, along with Property Managers ready to stay on after the purchase. This ensures a single point of accountability and significantly reduces risk for out of state investors. In addition, rent and maintenance guarantees are available on homes in some markets. HomeUnion provides post-purchase market intelligence, portfolio analysis, and management oversight for investors.
