How Do I Pick The Best Market To Work In?

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“What is good to research when looking for remote markets to hold property? What factors make a piece of property good to hold onto, make for good areas to hold, i.e. value vs. rent, demographics, finding good management companies and other good factors to consider?” – Todd

Joe: Well, you’ve hit the most important ones. First of all, if you’re buying properties for the long term to hold them, you’re looking at rent to price ratio – lower prices with higher rents for a particular area. In Indiana, I can buy properties for $40,000 or $50,000 that make me $800 to $900 a month in income depending on the neighborhood that they’re in or how good a deal I get.
 
Joe: But let’s say you’ve got a $50,000 property that makes you $800 a month in income. Is that better than a $100,000 property that makes you $1,000 in income which you can also buy in the same town? The rent to price ratio is much more attractive on the $50,000 property.
 
Joe: You have to find the sweet spot – you can also buy properties for $20,000 that are in warzones that have rents of $600 or $650. That would be better on paper than the $50,000 property as far as the numbers go, but the $50,000 property makes more sense because it’s in a more stable area and you’re going to have a lower cost and a lower vacancy rate.
 
Joe: The most important part is that you’ll be able to find somebody who will manage it. It’s very difficult to find a manager in warzones, so you have to be careful about that. You want to be in blue collar areas to get the highest price to rent ratio. This is all if you’re buying cash properties and you’re going to hold onto them. That’s what I do for my portfolio – my IRA Roth portfolio is full of properties like this.
 
Joe: We also buy “Subject To” properties. These are long term properties that don’t have a lot of cash flow in them, and the goal with them is to break even. When you buy a property that says it rents for $1,200 a month and your costs on it, principle interest tax and insurance plus property management, runs at about $1,000 a month, that’s okay and those are great long term properties, but you want to try to find fewer years left on the mortgage.
 
Joe: A lot of the ones you’ll find have 27 or 28 years left on the mortgage. That’s fine and you’ll be 70 or 80 or what have you when they finally pay off, but the rents are going to go up, so your cash flow is going to increase over time because rents go up based on inflation. Your taxes will creep up and your insurance may creep up as well, but the values will also creep up, so if you keep them for 10 years and the values jump up 20% to 50%, then you can turn around and sell them, make a chunk of money, transfer them on a 1031 exchange so you don’t have to pay taxes on the capital gains, buy another property under market value and do the same thing with that one.
 
Joe: But if you’re buying a property “Subject To”, you don’t have any money in the deal, so it’s just about managing the property, and if you have a property manager who’s managing it for you, you’re in great shape. And, if you’re selling it to a lease option buyer for a full price which is over what you paid for it, where usually you can get 10% more on a lease option deal, you can raise the price and take the lease option fee, about $5,000 or $10,000, out of the lease option and then you have that as income.
 
Joe: Let’s say the people stay in there for a year or two and they make the payments for you during that time, and then it goes vacant if they don’t exercise their option, then you can sell it again, and you get another lease option fee and continue to get the income coming in from it.
 
Joe: What I suggest you do is take some of that lease option fee and put it into an escrow so that when you do have a vacancy, you’ll have some reserves to cover it. Once you have multiple properties or you have up to 40 of these properties (and I have lots of students who do) then you don’t need to keep as much cash reserve. You know that maybe there’s going to be 5% to 10% vacant at any time, so make sure that you have enough reserves to cover two or three months of 10% of the properties that you have so that you can cover the mortgages and do justice to the sellers you purchased from.
 
Joe: The worst case scenario when you buy a “Subject To” you can’t make the payments on is that you give it back to the seller while it’s still current. If you’re going to fail, you’re going to fail in a way that’s not going to hurt them very much and it’s going to be no worse for them then than it would have been if they had not sold it to you in the first place. That’s the goal if you ever have to give a property back under a lease option.
 
Joe: When you’re buying these places, you want to look at the areas that have properties that fit the demographic you like. Now, if you’re buying “Subject To” properties you plan on keeping for the long term, you’re probably not going to buy properties that are over $200,000 because when you start getting over $200,000 (and there’s a few places that you can do this) you’re not going to have enough income from that property to pay the mortgage if its financed. Most of these “Subject To’s” are going to be financed at 90% or 80% of their market value, so you’re not going to have enough cash flow to do that. So, if you’re going to go after a “Subject To” campaign, it makes sense to do it in an area where the average price is around $100,000 or $125,000; those are great properties to do “Subject To” with.
 
Joe: It’s also great to do them in rural farming areas where you have properties that are $30,000 or $50,000. You can get $600 a month rent from properties like that. A lot of people own them free and clear and they’ll sell them to you on terms on a land contract with no interest, so for example, let’s say it’s a $30,000 property and you pay it over 10 years – just divide 30,000 by 120 and that’s your monthly payment; whatever makes sense for you so that you have enough cash flow to make your payment for these types of deals.
 
Joe: You can tell them how much you’ll pay and design it around how much cash flow you’re going to have in order to pay them off. But, if you’re not paying any interest, everything is going toward paying that off, so instead of doing a 15 year loan with interest, you can do a 7 year loan and pay it off at about the same rate, and then you own that property after 7 years and all of the income that comes in on that property is free and clear.
 
Joe: This is on cheaper properties, and we see this a lot in city properties and in rural areas as well, so there’s a lot of ways to do this. You’re going to base where you’re buying based on what you’re trying to accomplish.
 
Joe: There are ways to make money in high end markets, too, and usually that’s done by flipping those properties. If you’re in a high end market that you can get into and control and you know that that market is really hot and you have a 20% annual increase in that property, it might make sense to take that property “Subject To”, get control of it, don’t have the mortgage in your name and don’t have any money in the deal, and then take that property and maintain it, make sure the mortgage is paid, make sure there’s a tenant in it, wait a year or two and then turn around and sell it for 20% more than you bought it for.
 
Joe: If it’s a $300,000 or $400,000 property, that could be $40,000 to $100,000 of profit you can make within just a couple of years. The big thing to watch out for here is that this is predicated upon the values going up and you don’t have any guarantee that the values are going to go up and that you’ll be able to sell it for cash after that. So your exit strategy has more risk to it and less likelihood that you’ll actually accomplish it, but if you do it the way I’m talking about with seller financing it, your risk will be lower.
 
Joe: What happened during the boom in 2005, 2006 and 2007 before everything crashed is that in places like south Florida where the values were going up, they went up 47% in 2006, which meant that anybody that was buying a $400,000 property ended up with it suddenly being worth $600,000 in one year after they bought it. But then it crashed.
 
Joe: They had put money into those properties. They bought these properties, got control of them, put $80,000 down, 20% down, put a mortgage in their name, and then the values crashed and they went from $600,000 down to $250,000. And at that point, they would rent for $1,200 a month, but their payments were still up there in the $3,000 range. So they had these great big mortgages with negative cash flow and the only way they could get out of it was by trashing their credit or waiting and having these big huge negative cash flows. If they had bought it “Subject To” or if they’d bought it on terms or on a land contract, they never would have had that problem.
 
Joe: I don’t know if you’ve read or know my story, but I went through that in California back in 1991 when there was a crash there at that time. That crash wasn’t as bad as the 2007 crash, but when it hit me then, I lost all of my properties because I was mortgaged out and I was highly leveraged. I was making a lot of money – I had 17 million dollars of business going at the time – but I lost it all because I didn’t structure it properly.
 
Joe: When it happened in 2007, I was pretty leveraged as well, but I was leveraged in a different way, plus I had cash reserves, plus I had a lot of properties that were free clear, so I didn’t get damaged nearly as badly. We lost a little bit of money because we had some vacancies during that time because people lost their jobs, but it didn’t hurt me that badly, and I didn’t really lose – I just didn’t make as much as I had hoped for. So I hope that answers the question. Thanks.