Why I Don't Like Cheap Properties

Ever since the foreclosure crisis of 2008, there has been an endless supply of cheap houses with eager investors willing to snatch them up. But are these cheap properties with promises of great cash fow and high returns good investments?

Let me start by saying that "cheap" is all relative.What is cheap in one market is not cheap in another. A $75,000 3Br 1.5Ba in the midwest might look cheap to a California investor, but that $75,000 house might only be worth $60,000 and isn't such a great deal after all. Unsuspecting out of state investors often over pay when they think they are getting a great deal because they didn't take the time to understand values which can vary neighborhood to neighborhood and even street to street in some cities.

But a bigger mistake inexperienced investors make is not understanding the neighborhood on the ground level. They get lured in to buying super cheap propeties because the ROI's look so good on paper. Unfortunatley, most of those ROI's are about as good as the paper the pro forma's are printed on and never materialize.

Even when a buyer is fully aware that the cheap property they have found is in a neighborhood that they wouldn't dream of walking through themselves, they think that they can somehow find a good tenant that is more than happy to live there. Even if your property manager can walk on water, they can't work miracles and turn bad tenants in to good ones. And that's the problem with these cheap properties. Most are located in high crime areas that don't attract the most desirable tenant. They have high vacancies and turn over costs which are cash flow killers and can easily be the difference between a profit and a loss for the year.

Unfortunately, the real estate agent or the turn key company that you are buying from isn't always motivated to educate you on which areas to avoid. In fact, many agents and turn key companies focus on these low end neighborhoods because the returns look so appealing to out of state investors that don't know any better. When things go bad, the investor shouldn't be surprised. There's a reason the property was so cheap to begin with.

Crime level is the primary factor to look for when assessing and choosing a neighborhood and with the tools available today, there is no reason everyone can't research the crime rate of any area. Below are heat maps of two very different neighborhoods in Indianapolis.

Green represents low crime, red is high crime.

These 2 neighborhoods are only 3 1/2 miles apart. Where would you want to invest?

Do these cheap properties in low end neighborhoods ever pay off?

The only time I would recommend this type of property is to an experienced, local investor that already has a substantially large portfolio that is looking to exand and add higher risk assets. Think of it as stock. Would your first investment be a highly speculative stock? Probably not, so why would you make your first real estate investment speculative and high risk? Those that do get turned off when their investment goes bad and give up on real estate when the real problem was that they just bought the wrong property in the wrong area.

If you're thinking of investing in Indianapolis or Kansas City and want to know the best areas or the areas to avoid, contact me at mike@investwithpinnacle.com.