If you’ve invested in real estate long enough you’ve probably made some mistakes that cost money.
Or heard the horror stories that circulate on the web.
I’ve made several of those mistakes myself.
One in particular was when I bought a 12 unit apartment complex in an area of Birmingham that we believed was going to be revitalized.
A large local church had opened up a center in the area along with a clinic. And just on the other side of the train tracks was a great part of town where young professionals were moving in and changing the credibility of the area.
All positive signs.
However, we underestimated the criminal element in the area as well as the time and attention that these low income apartments required. We ended up selling the complex at a large loss.
I drove by the apartments several months back and they’re no longer there. They were bulldozed and I believe that a non profit organization is going to come back with something better for the community.
In this post we’re going to talk about the importance of doing your homework before you take substantial risk in owning rental real estate…especially in low to moderate income areas of town.
Mistake #1 – Morgan Smith
I asked one of our property managers, Morgan Smith, to describe a mistake he’s made in his investing career. We’ll also look at how this could have been avoided if he would have done his homework.
Morgan’s been investing for almost 10 years now and he recounted one of his biggest (and earliest) mistakes below:
“I purchased my first rental house for $81,000 in Tuscaloosa in 2006 with 80/20 financing after educating myself about leverage and housing. I was in school at the University of Alabama and I thought this would be a great way to earn some extra income.
Here’s a picture of me standing in front of it the day we closed!
The house was a really nice foreclosure and was ready to rent soon after it was purchased. It was a 3/2 and we started to try to lease it in the winter months.
As a rookie you can imagine how excited I was to start getting calls on my first rental house. Because I was so excited and anxious to start making some money, I took the first applicant that had enough income to qualify and who could come up with the deposit and first month’s rent.”
This was a BIG rookie mistake by Morgan and one that we see new investors/homeowners make all the time when they’re trying to rent out their house.
Renting a house takes patience and discipline.
It can take as many as 20 showings and 10 applications before we find one solid and approved tenant for a gk house. Morgan wasn’t being especially disciplined and he allowed his emotions to get in the way of solid underwriting practices.
Morgan explains further:
“Some unfortunate highlights of my deal:
- Thankfully the tenant stayed for 3 years. Unfortunately I had to evict her in order to get her out of the house. It was tough to think that this was my first property and first tenant ….and ultimately, my first eviction. Although we were in the middle of the eviction process, she ended up vacating before the Sheriff had to set out all of her things on the street. An interesting side note…in 2015 she ended up paying us her past due balance via collections (so I collected 50% on the $3,500 balance she owed us).
- By the time the tenant vacated my property, I had moved to Birmingham. When she left I hired a contractor from Birmingham, who moved into the house in Tuscaloosa and lived so he could fix the property and get it back on the market. That didn’t end up working out like it was supposed to…this contractor ended up stealing all my tools.
In hindsight, I should have never purchased this house because I knew I was eventually leaving the city. Real estate is long term investment and like all hard assets, selling is very costly and time consuming.
I was able to sell this house for $80,000 in 2012. A rough calculation of the numbers (rehab costs, ongoing maintenance, financing, selling costs and commissions, etc.), I would say I lost around $15,000 on my very first rental property.
While it’s hard to stomach a $15,000 loss (especially for a college kid!), it was valuable experience. All of the education I received at Alabama was not as practical as this one lesson. I gained so much knowledge and wisdom about managing property and handling tenants.
One of the biggest things I learned is that failure is guaranteed if you never even try.”
Currently, Randall “Morgan” Smith owns 35 single family rentals in Birmingham, Alabama, manages another 300 homes for gkhouses and continues to purchase property for the purpose of renting them.
So what’s the lesson for you and me?
1. Being extremely disciplined in your underwriting takes patience but will pay off with a solid tenant who may become a long term resident of your rental. This is huge…do your homework and stay disciplined to your criteria and process.
2. Understand the difference of managing property in and out of state. There’s a big difference and Morgan said he should probably never have bought that house knowing that he was going to be moving to a difference city. But if you do buy a rental property or decide to rent your own property and move out of town, make sure you either have a lot of experience…or hire a professional property manager.
Mistake #2 – Not understanding the street scene
I was with Wayne McGinnis (one of our property managers) the other day filming for some upcoming ‘owner education’ pieces and I noticed an interesting thing.
We were in an area of town called East Lake walking through a house that a tenant had just moved out of a couple of days before.
I noticed a house for rent across the street.
It looked like an investor may have recently purchased it, rehabbed it and was now marketing it with some street signs. Everything looked good at first glance.
But I started looking at the street scene and trying to figure out if I would have bought that house as a rental.
The answer: NO
Directly next door was a burned out house….and next to that burned out house was another burned out house!
Watch this video as I show you the house and explain the problem:
What do you think is going to happen to those houses?
I’ve met many investors who might believe that the owner will have those lots cleared and rebuild a house. I’ve met others who might believe that the lot is worth something.
Both of these assumptions are incorrect.
In certain areas the houses and the lots are worthless. At this point they become a liability for the owner.
And for the investor who owns that perfectly good house next door, it’s not a positive situation. It’s going to be much more difficult to rent that house with a burnout next door. Good tenants who will pay you every month don’t want to live next to a long-term vacant house or a burnout. Would you?
So, what’s the lesson for you and me in this situation?
Understand the street scene. Before you buy in a particular neighborhood, call some property managers who manage in the area and ask them about the street…the good, the bad and the ugly. They’ll let you in on the challenges of owning property on that street and in that area.
Remember that Google Earth images may be a couple of years old. I would ask for recent pictures of the house and the street…and by ‘recent’ I mean a week or two old at the most. Here’s a picture of the house in the video that I found on Google Earth today (12/17/15):
It’s worth noting that these two houses next door may have burned down after the investor bought the good house.
Regardless, this is a problem and an investor needs to know that these houses will never be rebuilt and that the best case scenario is the city tears them down within a few years.
This is all a part of the risks of buying in low to moderate income areas.
I hope this has been helpful for you.
- Do your homework
- Get good advice from local investors/property managers
- Know the street scene
- Understand the risk of buying in low to moderate income areas of Birmingham
Remember, you can call us at anytime if you’re looking for advice on certain area of Birmingham. We would love to help you make wise decisions.