My first investment property was a C/D-class multifamily in Houston. I selected it primarily based on perceived cash flow.
According to my calculations, the return on investment (ROI) was between 12% and 14%. And with a multifamily, even if one unit is vacant, I still have cash coming in. How could I lose?
And then I got hit in the face (wallet) with reality:
- It was an older building, and maintenance was continual and expensive. Plus, the tenants and others almost continuously vandalized the property.
- Rent delinquencies and evictions were frequent, and the process was lengthy and expensive. And I was left with a damaged property that needed hundreds or thousands in repairs before it could be rented again.
- I ended up losing thousands of dollars each year despite doing almost all repairs and maintenance myself. This was completely different from the calculated 12% to 14% ROI.
I could continue, but I will summarize my experience by saying: The second-best day of my early real estate investing career was buying that property. The best day was when I sold it.
I next purchased two B+ or A- fourplexes in a suburb of Atlanta. The tenants were professionals—no issues, low maintenance, no skips, no evictions.
What Did I Learn?
I learned some (expensive) important lessons.
The property type does not matter
Properties do not pay the rent; tenants do. If you want reliable income, start the property selection process by selecting a tenant segment with a high concentration of reliable tenants.
A reliable tenant stays many years, pays the rent on schedule, and takes good care of the property. Once you identify this segment, buy properties similar to what they currently rent.
You cannot afford to manage your own property
I didn’t know how to choose and manage tenants. They also knew I wasn’t a professional property manager, and they used my ignorance to their advantage. It took a lot of time and money when I had to evict tenants.
A property manager could have handled it much faster and cheaper. Plus, a good property manager might have selected better-performing tenants, and I would not have had so many eviction problems.
A property only attracts a single tenant segment, and you cannot change that segment
I wanted to upgrade the property and charge higher rent. However, if people could pay higher rent, they would not choose to live in the high-crime area where my property was located.
Leases, evictions, and even damage judgments mean nothing to cash-based tenants
There’s also no way to screen out bad actors with cash-based tenants. As one property manager who focuses on C-class properties said about her screening process for cash-based tenants: “…if they have two paycheck stubs and a money order for the first month’s rent, they are in.”
I asked about the tenant’s rental history. The property manager said that if they had multiple evictions; they just made up a name and alleged they were in the country illegally. Discrimination based on citizenship status is not allowed.
What I’ve Been Doing Differently
I shifted my focus from purchasing a property based on what I or others believe is a good investment to selecting a tenant segment with a high concentration of reliable people and then buying properties similar to those they are currently renting. I characterize the properties I want to purchase based on the characteristics of the properties my target tenant segment currently rents.
I call these characteristics a property profile. A property profile has at least four elements:
1. Location: The location(s) where a significant percentage(s) of the target segment rents today.
2. Property type: The type of properties they rent today. Condo, high rise, multifamily, single-family—the type does not matter. Only a reliable tenant matters.
3. Rent range: What the tenant segment is willing and capable of paying.
4. Configuration: This includes things like two bedrooms, three-car garage, large backyard, single-story, two stories, etc.
With a property profile, any real estate agent can find conforming properties.
Does this approach work? I have turned this process into a successful business. To date, we’ve delivered more than 516 properties. Over the last 16 years, we’ve only had six evictions, with an average tenant stay of over five years.
Final Thoughts
If you want reliable income, choose a tenant segment with a high concentration of reliable people. Then, buy properties similar to what they rent today. This process requires no guesswork, luck, or gurus, and it will work anywhere.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
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