Analyzing Rental Properties – Neighborhoods

Location, Location, Location

Continuing on with my series on analyzing rental properties I started by talking about doing some homework before you jump in.

We started it by looking at the local economics of where you’re potentially looking to purchase an investment property. Economic factors can help ensure the chances of your rental property being a success are multiplied, so if you’re just starting with this post, you may want to go back to part 1 Analyzing Rental Properties – The Economics

In this post I’m going to talk about neighborhoods which help ensure a steady stream of tenants and even better odds of hitting a home run with your investment rental property.

As the old adage in Real Estate goes, the three most important parts of buying Real Estate are location, location and location, although when buying rental property, it’s not the same location as buying your personal residence.

So many would be landlords see a house down the street from where they live come up for sale and they get the idea that it would be ideal as a rental property for them. Nine times out of ten, it’s not. In fact it could be the worst decision you make as a landlord and has the ability to permanently scar you.

The Pain

I’ve been there. I purchased the house beside mine years ago to help out the little old lady who wanted to move away. We tried to help her sell the property, but the market was very flat at the time and she was on a deadline, so we did what we felt was right and bought it os she could move on.

We were already experienced landlords with a couple years under our belt, so we knew it would work. Except with a high mortgage and low rents we new we would have some cash flow challenges, but if we could make it last a year, then we could sell it, yeah that’s it!

So we went ahead with it. We repainted, we fixed up some minor issues and we had a great property, just no one to rent it. Now since fortune favors the brave (or the uneducated initially), we managed to find some people who drastically needed to sell their home due to foreclosure issues and needed help getting back on their feet.

We were able to set up a win win solution where we took over their current home’s equity and renovated it, put it on the market as it was in a much higher demand area and sell it quite quickly. At the same time we moved them into the property beside us, used a portion of the equity as a down payment for a rent to own scenario for them and it all looked great.

They were actually paying less per month, we were making a few dollars as rent to own properties have higher rents and we had a bundle of cash from the flip of the other property. Everyone was winning.

They seemed like nice people, we got along quite well and several times they even joined us out back on our deck for a beer or glass of wine during the summer. Then the wheels fell of.

One of the burdens they had to deal with in their lives was a severely mentally handicapped daughter . She was fifteen years old, but mentally only reached the capacity of a two year old. Needless to say, but helping her and managing her was a full time job for the mom. Plus they had another son, so their days were full.

It started when they asked if they could get a dog. Pets are great therapy for children and apparently even more so for people with disabilities, so how could we say no? So away they went and picked up a mid sized dog, for a very tiny back yard…

A little more background, our former neighbour kept an impeccable yard. The rumours in the neighborhood was that she snuck out late at night to pull dandelions as we never saw any in her yard and the back yard was beautiful with banks of flowers across the back and a lovely covered seating area to relax in.

Well, in no time it was a complete mess. The lawn was dead and torn up, they never cleaned up the dog crap and it went from bad to worse.

Very unfortunately the daughter’s health deteriorated even more and she passed away. We felt awful. They had done so much to make things work for their child, they had given up so many things to make a good life for her and she was taken away by failing health.

The positive we saw on this was with the extra financial burden gone, they would be able to turn their life around and while this left a huge hole in their lives, it would ultimately allow them to move forward. We were wrong.

People Just Think Differently

We were actively growing our Real Estate portfolio plus I was working a demanding full time job at the time, but we wanted to succeed so we made adjustments to our lives. We only had one well used vehicle to save money, we rarely ate out and we scrimped and saved. We thought that was how everyone should think when they are trying to live up to their ambitions and dreams.

You simply adapt to make things work and start to think differently.

Not the renters next door though, although they did think differently than us. What little money they had left they sunk into their daughter’s funeral, which is understandable, but it left them with nothing and when their daughter first became sick (this last bought was over a few months), we did what we thought was the right thing and didn’t pressure them for rent.

We knew they were incurring significant extra costs during that time, the husband wasn’t able to work as much as he was needed at home and we could cover it. So by the time they had the funeral they already owed us almost $6,000. I know rookie mistake, but a compassionate mistake, after all they were not just my tenants… but they were my neighbors too.

Then the husband’s vehicle broke down, so they leased a new expensive vehicle, still not sure where that money came from if they couldn’t pay me. Next we noticed the wife had new shiny manicured nails, a brand new cell phone and they even asked if they could get a second dog!! All expenses we refused to splurge on for ourselves as we were very money conscious. We said no obviously and suddenly we became the bad people for refusing them.

The best part? We had front row seats as it all took place next door.

Finally, we find out from them that the government funds they were receiving to help with their daughter’s disabilities were “suddenly” cut off now that she had passed. Their free supply of money that was obviously just being spent on them now suddenly dried up. Were they thinking it just ran on forever?

This just made the likelihood of us ever getting the outstanding rent back extremely unlikely, so we were ready to pull the plug and evict them. Before that hppened,  they came to us and told us there was no way they could afford to stay in the property and had located a basement suite to move into, but couldn’t get in for six more weeks.

They were going from a 1,600 square foot single family home in a nice neighborhood, complete with a two car garage and a basement, to something under 1,000 square feet. Talk about a change of lifestyle.

I can’t even remember if they were able to get us any additional money during that remaining time they were there, but I know I spent every day hating the idea that money that should have been coming to me, instead was going to the shiny new vehicle in the driveway beside my  older vehicle. It was a very painful daily reminder of how I was being taken advantage of.

When they finally did leave, the property itself wasn’t too beat up, but the back yard was a disaster and we had to completely repaint and re-floor the property. We knew there was no way we could rent to someone next door again and that we needed to sell, so a significant renovation was in order.

In the end, the tenant walked away owing us over $10,000, plus we dropped another $20,000 in fixes and upgrades to sell it. The positive part of this was during the time the tenants were in there, the market had taken a huge upswing and even after all the losses and extra  expenses we still managed to make a healthy profit, but we were just lucky.

The TakeAways

The painful and expensive lesson we learned is that having your tenants next door or even near to you, opens up the door for more problems. Your relationship could evolve from just landlord tenant to a more complicated Landlord/neighbor scenario.

Part two of this is when things do go wrong , and there is no guarantee they will go wrong, it’s much more painful when it’s next door for you to see or you pass by it on your way home from work every day. Yes you get to keep a closer eye on things, but that too has it’s good and bad.

Part three, if things do go bad and it gets to the point where your relationship sours, do you really want your tenants knowing where you live, or having to see them almost every day? Especially if they are spending your money on themselves rather than paying the rent they owe?

Why take a chance?

In all likelihood the neighborhood you are living in isn’t the best location for a rental property anyway. Although the quality of tenants overall may be better in nicer neighborhoods, the quantity is way down.

This can lead to longer times filling vacancies while you are making payments each month on more expensive properties.

When buying in areas more prone to rental properties you have a much bigger pool of tenants to choose from and while you may have to put more work into screening, during tougher economic times you want a bigger base of potential tenants to choose from as vacant months add up quickly.

Also, buying rental properties in rental areas is usually much cheaper than purchasing in prime homeowner areas which can save you money to start with. Buying a property for less money and still being able to get the same amount of income is simply being smart.

Buying an expensive property in an expensive area and hoping to make money may work, but it’s much harder and has more drawbacks.

Most of these neighborhoods frown on renters. It’s the NIMBY mentality or Not In My Back Yard attitude. They complain about illegal suites (which they have a right too), they complain about too many vehicles, they complain about snow not being shovelled in a timely fashion or grass not being cut to acceptable lengths etc. And while these people exist in all neighborhoods, they are much more prevalent in owner occupied areas.

Even if you do everything right, if your neighbors find out your property in the nice neighborhood is a rental, it gets a bit of a social stigma. Yet if you buy in a rental area where you have a huge pool of tenants, it’s just another property in the neighborhood.

Yes you may have a longer drive to randomly check up on your property, but the other benefits outweigh this by so much!

The BottomLine

You have to do what works for you. I’ve given you my example of what can go wrong and I’ve explained why not renting next to you works better. If you’re already living in a rental neighborhood, you may not have an option, or if you’re in a small town it’s hard not be be near your rental, but if you have a choice, don’t make it too close!

The benefits of purchasing a rental property in a rental neighborhood are they are typically a bit cheaper, they typically generate better overall cash flow, renovations cost less, you have more tenants to chose from and they can often be suited providing you with multiple streams of income from one property.

The benefits of buying in your possibly upscale neighborhood is that it’s close, you can keep an eye on your tenants, the initial price is higher so % increases in value reward you more and the class of tenant is typically better.

The negatives of buying in a rental area is you have to do more thorough screening as it’s quantity versus quality, the initial price point is lower so if values increase x% it would be smaller than if on a more expensive house and it may not be near by where you live.

The negatives of buying in your neighborhood that is not a rental area are far fewer tenants to choose from, so longer periods of vacancy, lower amounts of cashflow, renovations are typically more expensive, if the relationship sours, you have to deal with it often on a daily basis and your property can suffer local stigma for being a rental.

There are people who buy near them and run their property successfully, with only one property this may work perfectly for you. However, all the investors I know who buy multiple properties tend to buy them further afield and usually in specific areas designed to generate the best chance of success and the most cash flow and I can’t recall any of them buying the rental next door or down the street from themselves.

And if they don’t do it, why would you?

So, this has been one of my longest articles ever, so I hope you got some value from it, I’d love to hear your comments and stories about your rental properties. Are they in your neighborhood? In rental areas, or next door?

The next article will be the third in this series and will talk about local rental markets, I hope to have it ready for you soon!

FYI, this is how it looked when we were done,