Partner with Your PM Before Acquiring Property
Property managers may have local knowledge that can help you with your acquisition decisions.
Many investors, especially new ones, are woefully unprepared for the road ahead of them once they purchase a property. And that’s almost always due to bad information.
Where is this bad information coming from? Why are these investors taking bad advice over and over again? This bad information, more often than not, comes from out-of-area single-family residential (SFR) “experts.”
The 1% “Rule”
Have you ever heard of the 1% rule? If you haven’t, here’s a quick explanation.
The 1% rule is a “rule of thumb” for SFR real estate investors to determine whether or not a property is a good buy. It is often used in place of cap rates as a quick and dirty determination for expected income on a property. For instance, if you purchase a property for $90,000 and its market rent is $900 a month, then it fits the 1% rule. You’ve found an excellent deal!
Not so fast. Any real estate investor who’s been in the SFR space for any serious period of time can attest that these deals often are not as good as they sound.
Many green investors have high expectations, thinking they just purchased some golden goose, holy grail of a property that will be the first of many to come. Or, they’ve heard about a great “supplier” that is selling homes at 1% all over the market. They are ecstatic they can finally turn their “part-time dream” into a real business.
Unfortunately, many of their dreams (and their wallets!) are shattered when they learn the true costs of what they have just purchased.
Local Knowledge Matters
When an investor buys a home based on the expectations of the seller, it doesn’t take a rocket scientist to find the problem. And, even when investors use their own representation, lack of local expert knowledge can end in disappointment.
This is, in a nutshell, why a consultant with local expertise matters.
Without getting too much into the weeds of local market data, let’s take a look at three different (hypothetical, but typical) properties.
One is listed at $60,000 and needs new systems, possibly a roof, perhaps some paint, so the total investment should be around $80,000. Market data shows the market rent should be around $800 once it has been fully turned “rent ready.”
Property 2 is listed for sale as a “rent-ready” property and is listed for only $75,000. Pictures show some dated walls and stained carpet, but it looks livable. The market looks like it is bearing $950 in this area, so it looks very promising.
Property 3 also looks “rent ready” and has tons of pictures showing a great interior rehab. It is listed for only $65,000, and market rents are around $750.
We’ll assume these are all cash purchases, so we don’t have to worry about mortgage rates and so forth. So, all three properties look great and meet the 1% rule, right? Property 2 tops the list with 1.26%, followed by property 3 at 1.15% and, finally, property 1 with a solid but outclassed 1%.
These three properties are based on typical properties in three separate areas of the Birmingham, Alabama market. There are amazing local realtors who know these markets well and can help even green investors make money. It would be likely that all three of these hypothetical properties would make money, but which one is a better buy and why?
Here are some things to consider.
If property 2 does rent for $950, that doesn’t mean $11,400 per year, or even $10,260 (derived by subtracting 10% management fees). Why? Property 2 was in “rent-ready” condition only in that it was livable. The $950 rent rate is based on averages. This property is below the average in terms of desirability.
The stark reality is a C-class home has a higher maintenance cost, higher vacancy rate and a generally lower appreciation over the long haul. Many municipalities even have fees associated with being a landlord that your realtor might not be aware of.
In the case of property 2, the grim reality is that this property will likely only return around $3,500 in the first year. Even when you calculate out a 3-year proforma, the profit is only $15,633. The variables taken into consideration by a property manager will include valuable data that many others do not track.
Based on the same variables modified to fit property 1, the first year returns $4,377, and after three years the total builds to $16,519. The difference is only an increase in $886 in rent, but the additional factor that may be hiding is resale appreciation.
These three hypothetical properties are based on three very real markets. Property 1 has seen not only a 4% increase in rental value each year for the last six years but also a 13% increase in home value. Property 2 has seen a steady 2% increase in rental rate, and only 6% increase in sales value. Property 3 is the most deceptive as neither the rental value nor sales value have any significant increases in years. This market also has one of the highest delinquency rates and maintenance costs of any market in the area.
The key factors that set any realtor apart is data and the ability to analyze it. The data a local expert can provide makes the difference between consulting and just another sales pitch.
Property managers and realtors can make excellent teams of consultants. Always use your network to find experts in fields that you lack. One of the best networks for anyone looking to find excellent in-depth local knowledge is the National Association of Residential Property Managers (NARPM). You can check them out for a local property manager in any area of the U.S. Knowledge can be as valuable as any deal you may stumble upon—and sometimes much, much more.
