I have a love-hate relationship with my cheap rental property business.
You see, it was a cheap rental property got me started investing 10 years ago but have also held me back from quitting my job even sooner than a desired. These are properties that you can purchase for $10,000 cash and rent to a tenant for $550 a month.
On paper, all of my $10,000 properties should bring in $8,500 a month in cash flow. The reality is that they usually bring in a little more than half of that.
In 2006, I decided to start investing in rental properties but found that properties in California were way too expensive to buy as rental properties. Without knowing much about rental investing, I started looking all throughout the country for rental properties. On eBay of all places, I found a duplex for sale for $60,000 in Ohio. Coming from the California market where a duplex would be $300,000, this duplex in Ohio sparked my interest.
I convinced a friend to fly with me to Ohio to look at this new area and try to build a rental property business halfway across the country.
Looking back, I did everything wrong but I would not change a thing because it has gotten me where I am today. I did not meet with multiple realtors, only met with one property manager, and looked at a couple of houses. I will explain all my mistakes in the future post.
So after seeing the area, economy, clientele, properties, etc. I found that a $60,000 duplex was way expensive. Properties like that should be selling for 30,000 as opposed to 60,000. Apparently someone bought the duplex at the peak of the market is trying to sell it for as much because. Even though I didn’t know what I was doing, I passed on the property just because the price is way too high let alone finding out the profitability of the property.
My First Purchase of a Cheap Rental Property
The first house that I bought was listed for $25,000 and was a three bedroom one bath single-story house. With negotiating, I talked the seller down to $17,000 and purchase the property for cash. I got the property rented within a month or two and was immediately seeing passive income every single month one property.
I rented it for $550 a month and after expenses was clearing $450 a month in passive income! That is an increase in my yearly income by $5400!
This one property got me hooked on the business of cheap rental property
It’s almost like a drug, you can’t get enough. Every time I wanted to go away from the area I found that I could not find a better rate of return for my money.
I saved all my money to buy more properties and kept buying more and more of these cheap properties.
I even bought a bank owned property for $6,500!
The bank had it listed for $19,000 and I offered $6500. They did not counter so I left the offer and went on to purchase other properties. Usually, I negotiate heavily to get the lowest price possible and I start at a ridiculously low offer. I would normally start at $6500 and work my way up to a final price of around $10,000.
Because the seller did not counter my offer with a lower offer, I figured they did not want to play ball so I moved on to other properties. Six months later I received a call from a realtor asking me if my $6500 offer was still on the table because the seller wanted to accept it.
I told him, “Absolutely!” and then bought it for $6500.
I still own the property today and it rents for $450 every single month! I have every penny of mine back in my pocket and all future money is all gravy.
So, let’s get to the good and bad things about $10,000 homes.
The Good Side of the Cheap Rental Property
Barrier to Entry into the Real Estate Business Is Extremely Low
Being able to save up $6500 to buy one property may take a year or two for most people if they try hard. Depending on your income and expenses, you may be able to save that much money in six months.
I have many new investors ask me how they can get started investing in real estate with little to no money. I reply to them that I had little to no money to begin with and just found a property that fit my criteria and went for it.
Even if you are not able to find for $6500 house, you may be able to save up $6500 to put as a down payment on $150,000 house with a FHA loan. Since an FHA loan only need 3.5% down payment, you should be able to save enough money to buy your first rental property.
Depending on how much the property could rent for, $150,000 house could potentially make you $300 to $400 a month in passive income. The key is to just get started investing and get over the fear of potentially losing money.
If you follow how I buy properties, you will never lose money.
Cheap Homes Have Amazing CAP Rates
The capitalization (CAP) rate is the ratio of net operating income to the purchase price of the property. For example, if you purchase a home for $100,000 and it produced $10,000 a year in net operating income, then the Rate would be 10%.
$10,000 / $100,000 = 10%
let’s look at the Rate of my $6500 property. I paid $6500 total for the entire property and it rents for $450 a month. After taxes, insurance, and property manager fees, the income is $300 a month. $300 a month times 12 months equals $3600.
$5400 / $6500 = 55.38% CAP rate!
Think of what that actually means. In one year I made a 55% return on my money!
Those who put their money in the stock market dream of getting 12% return on their money each year and I made a 55% return on my money in one year! (If the property is rented all year with no other expenses. We’ll get to that in a bit)
The Passive Income Snowball Grows Very Quickly with $10,000 Properties
Imagine you bought five properties that cost anywhere from $6500-$10,000. Each of these properties would bring in $450-$550 a month. After expenses you are looking at $300-$400 in passive income each month.
$400 times five properties is $2000 a month in passive income!
After a while the Snowball of your passive income gets bigger and bigger. As the snowball gets bigger, it continues to grow and get even bigger. Unless you are unwise and spend your passive income on things that don’t make you money like cars and TVs, you can say that money and buy another property very quickly.
If you’re making $2000 a month in passive income, after five months you had $10,000 to buy another property that would make you $550 a month. Each five months after that you buy another property, then another property, then another property.
I think you get the picture.
This is what I did with all my properties. I bought one the first year. One the second year, three the third year, and for the fourth year. After a while, I couldn’t help but buy more and more properties.
The Bad Side of the Cheap Rental Property
There are some bad things about the cheap rental property that you must be aware of before you jump into them. I will say, however, I would personally not hesitate to buy a cheap rental property again. Actually, I just bought a cheap rental property 8 months ago!
This property I bought it for $9000 and it was already rented for $500 a month!
This property has made me money from the first day I bought it. After all expenses, I make $338 a month which is $4056 a year in passive income!
CAP Rate is: $4056 / $9000 = 45.06% return in one year!
Repairs on the Property Can Add Up Quickly
Because these properties are cheaper, they are probably much older than more expensive homes in other areas. The property I purchased for $6500 was built in 1917!
The problem is that homes like this have lots of differed maintenance that they require in order for them to be occupied by a tenant. This $6500 property needed about $2500 to get the first tenant into the property.
Now, all of the mechanical in the home are various ages and these may need to be replaced as early as when you take ownership. Here is a list of things to look out for when purchasing a cheap rental property.
|Mechanical Items to be Checked:
||Other Items to be Checked:
You know what, just hire a good home inspector.
Seriously! Find a good one on yelp.com that has plenty of good reviews and have them inspect the property.
And YES! You should ALWAYS get a home inspection no matter how good you think the house is. $350 home inspection could potentially save you thousands of dollars in the log run.
Don’t go cheap and skip the inspection for ANY property you buy.
If a home was built in 1990, most of the items in the home are still in good repair and do not need much money to get fixed up. You pay more up front on the purchase price but there is less coming out of your pocket in the log run.
With a 100 year old home, there can be many things that are going wrong with it. Even though you pay a lesser price for the property, it takes more money each month to maintain the property as opposed to the 25 year old property.
So, be ready for more monthly expenses in the form of repairs for a cheap rental property.
The Type of Clientele May Not Be the Best Tenants
These properties will have a much different type of clientele than homes located in sunny San Diego near the beach.
The type of clientele that you would get for these properties tend to be more lower class and transient than other tenants. It is possible to find great tenants in these areas but it is VERY easy to find bad tenants.
Think about it.
If a tenant cannot save up $6500 to purchase a home in their area, they may not have enough money to pay rent. OR, they don’t know how to spend their money wisely and blow all their money away on useless things.
I have a fellow investor that had 3 evictions a year for the past 5 years. He has never seen any money come in from that property and eventually sold it.
Things bad tenants will do:
- Not take care of the property while they are living in it
- Not pay rent and accumulate lots of late charges
- Instead of moving out, they wait until the last day of the eviction process to move out
- They do not clean out their junk when they vacate the property
- They leave animals inside the house leaving feces all over
- Run up a huge water, electricity, or city bill and leave the owner with the tab (yes, I have had an $1800 water bill from 3 years of bad tenants in one property. The water bill stays with the property, not the tenant!)
- Tell you lies about where their money is or how they had a doctor bill so they could not pay rent.
I’m sure there are many others but this list will get you started.
Way Around the Problem of Bad Tenants
Background check, background check, background check!
Without a background and criminal check, you are opening up yourself to lots of problems and loss in money. For years I didn’t do a background check and lost money because of all the evictions. As soon as I started background checks, my eviction rate dropped because I was able to screen tenants much better.
I once had an applicant for one of my properties who was evicted 4 times in the last 3 years! Needless to say I did not let her rent the property and saved myself loads of money.
Crime in These Cheap Rental Property Areas Tend to Be High
In every town, there are good areas and there are bad areas. Even for a cheap rental property, you can find good ones in good areas. BUT it is harder to find these areas unless you know the area yourself.
If you are an out of state investor like myself, What looks like a good area may be the worst area of town with LOTS of crime.
In my cheap rental property business, I have had my properties broken into many times. Mostly when it is vacant, a thief breaks in and steals all the copper plumbing to sell it for $15 at a recycle yard.
I have also had a property broken into where kids party all night like it is 1999. Sucks but it happens.
Ways to Get Around the Problem of Crime in Your Cheap Rental Property
Find and keep good tenants in your properties. Most vandalization and crime is when the property is not rented. Obviously thieves have a much easier time taking things when no one is in there.
After you background check and find a good tenant, try your best to keep them in there.
Also, you should buy in good areas by listening to the people who live there. I listen to my realtors and property managers on the areas I should and should not invest. They know exactly how a neighborhood is and the type of property you would be buying.
If they tell you that the property is not in a good area, STAY AWAY!
Vacancy Rate is Higher than Normal Areas
The vacancy rate/factor is basically how long your property is not rented in a given year.
This rate is to be used for prospecting your future income from the property. If you believe that your property will be rented 12 months out of the year, then you vacancy rate would be 0%. Honestly, you should always have at least a 5% vacancy rate in your cash flow projections.
If your property is not rented for 1/2 a month out of the year, then it is only rented for 11.5 months. That means that the vacancy rate is:
15 days / 365 = 4.11% vacancy rate.
Whatever you believe your yearly income is, divide that by your vacancy rate.
If I believe my property rents for $450 a month, then it would earn $5400 in passive income each year. Now you take the $5400 and multiply it by the vacancy rate of 4.11%.
$5400 * .0411 = $221.94
That would be $221.94 loss out of the entire year of $5400.
To add this into your monthly expenses, you take the vacancy amount in dollars and divide it by twelve to see how much it will take out of your monthly income.
Your vacancy rate expense for this example would be $18.50 a month. Add this to your other expenses like, insurance, taxes, property management etc. to get your total expenses.
A big problem for the cheap rental property is that these vacancies can eat into your passive income quickly!
Fluctuation in Passive Income
Needless to say, with all these bad things about a cheap rental property can make your passive income be much more fluctuating than you would like.
I personally would have quit my job 3 years ago with my properties if the cash flow was more stable. One month I would get a check for $7000 for one group of properties and the next month I would get $2000.
There was a three month stretch that I had so many evictions, repairs, fix-ups, etc. that I only got a total of $353 from all three months.
The rest of my money was going to the cost of evictions, the clean out of properties, repairing electrical, etc.
Ways to Make Your Income More Stable
Basically, if you implement what I have shared here in this post, you will be able to make your income more stable and not have such huge fluctuations in the money you receive each month.
So, I LOVE and HATE my cheap rental properties because they are great cash flow but can really hurt you when things go bad. Many other areas I invest in do not have these problems. My higher priced homes get a higher rent and cost much less to fix.
How about you? What is your experience with a cheap rental property?
Leave me a comment below.