When you’re getting into real estate as a beginner, cheap properties seem like an attractive option. You want to start investing for the lowest amount you can. After all, a $30,000 property isn’t nearly as much as a $90,000 investment; there’s less equity, less debt, and it seems a lot less scary.
However, there are a plethora of reasons why you should avoid investing in cheap property.
- It could be in a bad location.
- There is the possibility of many hidden issues with the property.
- The neighborhood value is low.
- Cheap properties with low rent may not attract your target renter demographic.
- You may not be able to use leverage when buying a cheaper property.
You Don’t Want a Bad Location
The magic words of real estate investment. Of course, it matters what you’re investing in. But it’s just as important, if not even more important, where you’re investing. You could find the perfect place that’s affordable and seems like a great investment.
However, if it’s not in the right place, it’s not worth it. Why does location matter? Why is it such a big deal?
It all comes down to the locational attributes. Depending on where the property is, you could have higher rents, higher property values, higher market interest, and so much more.
Being in a good neighborhood is important, having access to high-quality school districts is important, the distance to downtown or the CBD is important. All these things matter towards your investment.
- CBD: Central Business District. A fancy way to say ‘downtown’.
Hidden Issues With Cheap Properties
When you’re looking at a cheap property, you have to ask yourself: “why is this property so cheap?” Especially if the investment seems too good to be true.
There might be something wrong with the property, the foundation may be messed up, the HVAC or roof could be deteriorating, amongst so many other hidden issues.
You have to be so careful when you’re going into a cheap property, and be cautious and inquisitive about why the property is so cheap.
You don’t want to be placed in the position where you think you’re getting a steal, but the repairs end up being so much more than the investment was worth. If the house was $50,000, but the roof repair is $20,000, the time and money you waste will not be worth it.
Low Neighborhood Value
Residential real estate is largely focused on the neighborhood and its value. It doesn’t matter if your investment is the nicest one on the block, if the surrounding properties have the same value, you’re not going to be able to sell for much more than the neighborhood value.
At the end of the day, nothing you do will be able to dramatically increase the value of your home, if the neighborhood value is low.
Why is that? The way residential real estate works is that value is based on what your neighbor’s values are.
It’s important to look at the neighborhood to determine if the property will grow in value. You want to achieve the three goals of real estate investment:
- Cash flow
- Make money on your taxes
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You have to consider the type of renters you’ll draw if you have a cheap property. It’s important to draw in the right kinds of renters; you want renters with solid income, good credit, good rental history, and solid references.
If you want to check your own credit score, you can do so with Experian.
If you have a $40,000 property in an area with high crime, bad school districts, few locational attributes, you won’t be attracting the ideal renters.
A good rule of thumb: if you wouldn’t want to live in the property or in the area, you shouldn’t be investing in them either.
You Might Not Be Able to Use Leverage
When you go to the bank, there’s a limit on the amount you can get from the bank. They will usually limit you to a 75% LTV
- LTV (Loan to Value) ratio: a ratio that examines the relationship between the loan amount to the value of the asset. It’s an assessment of risk from the perspective of the bank. Higher LTV ratios are higher risk for the bank and vice versa. Typically higher LTVs will also come with mortgage insurance and/or higher interest rates.
This means that if you’re buying a $50,000 property, and you decide to finance the loan, it’ll be almost impossible to finance it as an investment property. It’s common in these scenarios for the buyer to just outright purchase the property in cash.
However, we don’t want to do that! Using leverage is a really great way to stretch our investing dollar and get the best property/properties we can for cheap.
You can use leverage to get a better property, which will mean better rents, better cash flows, better tax benefits, AND appreciation.
It may seem like a good idea to go for a cheaper property so you can pay with all cash and not have debt, but using leverage can be an effective strategy.
If you want to invest in real estate for no money down, check out our series on this topic:
- How to Get Into Real Estate With No Money Down-Seller Financing
- How to Get Into Real Estate With No Money Down- Hard Money and Gift Money
- How to Buy Real Estate With Credit Cards
Low Income Doesn’t Mean ‘Bad Neighborhood’
Throughout this blog, we talk about ‘good’ vs ‘bad’ neighborhoods. It’s important that we distinguish that a bad neighborhood isn’t characterized by low income. Good neighborhoods are defined by locational attributes like distance to retail and grocery or low crime.
Low-income neighborhoods can be great neighborhoods, and shouldn’t be avoided. Low-income neighborhoods can have affordable (not cheap!) properties with high rent-to-value ratios. Additionally, low-income neighborhoods are not as impacted by economic volatility as other neighborhoods and could provide the stability that higher-income neighborhoods couldn’t.
Buying cheap properties can be an investment option that yields substantial profit and high cash flows, but only if done very carefully. As the saying goes, “the better the neighborhood, the better the investment.” If you invest in a cheap property, you make get bad renters, not be able to use leverage, face issues with a low neighborhood value, and more. It’s important to make sure that you’re able to create a steady cash flow, sell it at appreciation, and make money on your taxes.
Investing in real estate will allow you the opportunity to have the financial freedom you deserve, but there are many barriers and challenges to real estate investment. The Orlando Academy created a “Real Estate for Beginners” course, based and designed around Orlando Miner’s 10+ years of real estate investing experience. With over $500,000,000 in transactions closed, the program has been proven to work over the last 15 years.