Finding the Right Neighborhood

by | Aug 17, 2018

 If you go to your Multi-List System, you can do an advanced search. What sold in the range of $0 to $500,000?What sold in the range of $500,000 to $1 million? That may need to be broken up into multiple ranges. When you get to $1 million and above, that will dwindle – unless, of course, you’re in Southern California, where everything seems to be over a million dollars.

But when you get to say, $2 million and above, the air is thin up there. There are not as many properties, not as many people, and consequently, things move slower at that range. It’s a lot more difficult to make money investing in the

“A” neighborhoods. You can do it; you can flip in these neighborhoods when you’re in a hot market. A hot market could be applicable to a middle-range neighborhood (that’s middle-class and upper-class). You’ve probably noticed, in an emerging economy, usually things rebound at this level first. Every now and then we’ll see a trend that’s contrary to that – where the affluent neighborhoods kick things off first – but that almost never happens. As a result, it will be very difficult to make money by buying properties for renting. These almost will never be cash flows; sometimes they’re negative cash flow.

“A” Neighborhoods

Some people do buy these properties for rentals, and generally, they are just looking to bury their money. They’re looking for a placeholder, to keep their money in a holding tank, and for some reason, they’re okay with taking a loss. I don’t care – they can call it a paper loss all they want. A loss is a loss.

All of the loopholes prior to 1986 are gone. I usually do not recommend investing in “A” areas for either flipping or renting. It is very risky to tie up a million dollars. If things don’t go right,you’re going to feel that pain a lot more than you would in a $150,000 house, I can promise you that. I don’t care who you are; it’s going to hurt.

“B” Neighborhoods

“B” neighborhoods are your middle class. Again, it depends on what area of the country you’re in parts of California the middle-class earns $600,000 annually. There are parts of Georgia and Texas however, where middle-class is $60,000 right now.

That might be a little aggressive, but the median, average home value is what you want to look .If you’re flipping, you want to be at that level. You can go down a little bit, slightly below it, and you can go slightly above it.

In an emerging economy, I would push a little bit. I would start here and maybe push up, push upper boundaries of that middle class range for flipping. You’ll see why, because as prices are rising, you want to lead the market.Last quarter, average home prices were $215,000. When prices are rising, you want to push it to say, $225,000 to $235,000, or maybe even $240,000. Push it by about 10%. In a declining economy, you have to price down to be in front of the curve. If the average home price last quarter was $215,000 in your area, you need to drop your price to about $199,000. If you don’t get there, leading by the right price, you will eventually get there by lagging, stagnating, and price-dropping – basically harming your client. I know clients have a lot of influence. I understand. But you’ve got to learn techniques to speak with and negotiate with your clients, so they don’t hurt themselves. If you do, you will have a friend for life. With flipping, you want to be right around that median home price mark. That’s where you’re going to get the most traffic

“C” Neighborhoods

These are generally lower-income areas or below middle-class. This doesn’t mean they’re bad areas. They are just populated by people who don’t have the financial resources, income, or wealth to be in middle- or upper-middle- or upper-class.

Typically these neighborhoods are populated by renters. There are plenty of people out there who have lower incomes who are good renters. They’re great, and they’re going to be in these types of neighborhoods. You can squeeze up in the upper bands of the C-grade areas, and you can squeeze into the lower bands of the B-grade areas when you’re renting. What will happen is your ratio of rents to cost basis is going to start to suffer, which means your cap rate is going to start to suffer (cap rate being your net operating income divided by the cost basis of the property that you’re purchasing).

The lower that number, the less rent you’re bringing in, but also the less risk. The higher that number, the more rent you’re bringing in, but the more risk. That rent is going to cost you more time and energy to collect.

Those properties will be more management-intensive. If your investors are in an area where cap rates are at 15%, that’s okay. They just need to understand they’re going to have to work harder for that 15%. They’re going to work far harder for their rents, versus an area where the cap rate is closer to 10% and below. You’ll have better quality tenants, less problems, less management intensive, but you’ll also make less money.

So for rentals, particularly for investors who are starting off, I recommend going in this range. Now every investor will have his own agenda. They might say, “I don’t care what you say. I’m investing in rentals in this area.” That’s great; they just need to understand that their gross monthly rent multiplier may only be 1% of the purchase price, whereas in the “C” neighborhoods it may be 2%. In other words, if a $100,000 building brings in $1000 a month in rent, that’s 1%. A $100,000 building bringing in $2000 a month in rent, is 2% of the gross monthly rent multiplier. It is a matter of cash flow. I recommend higher cash flow properties. I am not afraid to say I started off building my portfolio in “C” neighborhoods.

I pushed up a little bit as the years went on, buying larger complexes. But all of the investors I represented almost inevitably ended up in this area. But I do not advocate dropping down below this area. The next lower band is C-minus. Every now and then you will notice a boarded-up house on a long street or somewhere in the neighborhood. If there is one, no big deal. When there are multiple boarded-up houses, you are getting into what we call “warzones.” I don’t advocate investing there.

I recommend C-grade neighborhoods for investing in rentals. Not C-minus – the war zones. If you see cars on blocks, boarded-up houses, empty lots with trash thrown all about, and you don’t see anyone out walking around, that’s an issue. You need to find neighborhoods to invest in where there’s foot traffic. People are walking. People are jogging.

People are cutting their grass and trimming their shrubbery and keeping up their cars outside, and keeping the yard free of debris and all that kind of stuff. It doesn’t mean they are better neighborhoods, it just means there are good people living in those lower-income neighborhoods.

A-B-C properties, avoid the war zones.

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