A Cheap House Is Not Necessarily A Bargain

by Silicon Valley Blogger on 2009-11-1222

Some considerations before you decide to buy a foreclosure.

Are You Getting A Bargain? Not All Undervalued Homes Are Good Buys

A bargain is synonymous to a “great deal” — something that has value and has an ROI. The truth is, not all cheap houses are great deals; in fact, some are considered liabilities. But let’s not forget that liabilities can be found anywhere as well: for instance, I once discussed how some friends made a bad investment and lost a million dollars on a vacation rental they owned.

These days, cheap homes are everywhere, especially in certain residential communities that have fallen into foreclosure. I still can’t seem to wrap my head around how Detroit houses can be purchased for a third of the money you’d need to spend for a new car. That’s also because that same $7,000 house in Detroit would probably fetch several hundred thousand dollars if it were located here in San Francisco: I can’t find any homes here that will go for less than $100,000.

With these fire sale prices around the nation, people are flocking to buy foreclosures and hoping to pluck some distressed properties off the market. Before you indulge your dream of finally becoming an absentee landlord, check out these lessons on real estate investing that I picked up from CNN Money:

Lesson 1: Forget about flipping. The days of fast appreciation in home prices are now over. So if you’re going to invest in real estate, you’ll want to make money the way it’s traditionally done: through rental income and cash flow.

Lesson 2: Realize that the property’s purchase cost is just the start. With any piece of property bought, there’s always going to be ongoing upkeep, along with taxes (depending on where you live). But the crappier the house you buy, the more money you should expect to spend on fixing it up to be ready for use. So just keep in mind that even with a super cheap house, your costs can balloon after all is said and done.

Lesson 3: You’ll need cash. With the tough credit environment, it’s much harder to get the financing you’ll need from banks to bankroll your real estate investment plans. Those with cash will have an advantage in this market.

Lesson 4: Know the neighborhood. While it used to be just “buy, flip and profit” some years ago, these days it’s all about finding the diamond in the rough. With so many cheap houses vying for your attention now (who knew that a buyer’s market could be such a hassle!), you’ll need to do some due diligence. You can’t buy blindly like real estate investors of years past were wont to do — or you’d risk making an erroneous investment decision.

Lesson 5: Know and screen your tenants. With the economy in the tank, you can bet that it’s probably going to be more of a challenge to find good, reliable tenants. Aspiring landlords will be facing more work and spending more time screening for the right people to rent out to.

Image from The Truth About

Thoughts On Real Estate Investing

I’ll admit that when the real estate market was soaring, I too, fell under the spell of wanting to be a landlady one day. I had this interest (“dream” is too strong a word) to try out rentals as an investment. Now that the market has crumbled, I’m no longer as interested in this endeavor, and have discovered that this is really not my “thing”. You see, if you are truly a landlord at heart, you’d stick to your calling through thick and thin. When you evaluate the things you’d like to spend your time doing, you’ll know that something is “in your blood” if you’re willing to do it even with much less money involved.

On that note, I’ve decided that real estate investing for me will be relegated to REIT investing. And for cash flow, I’ve instead decided to stick to investing in “virtual” real estate, or web properties, if you will. I think I’ve established that this is how far I’m willing to stretch beyond my comfort zone.

Copyright © 2009 The Digerati Life. All Rights Reserved.

{ 22 comments… read them below or add one }

Kelly from Almost Frugal November 12, 2009 at 1:48 am

I totally agree with you on how you know if something is for you or not when you’re willing to do it for less money. Life is about appreciating what you have and what you do, in my opinion!

Financial Samurai November 12, 2009 at 2:28 am

Right now is a fantastic time to buy rental properties. We’re talking 7-10% rental yields vs. a 3.5% 10-year treasury yield. Juicy. Gobble gobble!

Paul November 12, 2009 at 7:49 am

All 5 are excellent points. However, it’s interesting that you should lose interest when it is the best time for a long term buy and hold strategy in real estate investing. This parallels peoples desire to get into the stock market when it is at it’s peak and sell when it is at a bottom.

I’m not truly a landlord at heart either (I’d rather be sailing), but knowing the right time to invest in any enterprise plays a large part in your financial success.

Silicon Valley Blogger November 12, 2009 at 8:32 am

I realize that real estate market is great for bargain hunting right now — if anything, I see myself as an investing contrarian. However, I guess it’s a matter of how much time one can/should apply to their chosen “calling” (hobby, work, projects, etc). It seems that this kind of investment takes significantly more time to understand and deal with than dealing with the stock market. You can also get real estate exposure to *some* degree through REITs. I’ve read a few books that recommend REITs over actual ownership of property as a way of gaining that access. I suppose it’s for people who don’t have the time, energy and commitment to deal with it.

I’ve got a few friends who are happy landlords. But it seems that they lucked out and got the best long term tenants in the world. Then I hear about my pal Lazy Man (of Lazy Man and Money) talking about what he deals with on a regular basis. Seems like there’s always something breaking down, flooding, needing repairs at his rental in Boston and he says it isn’t exactly a big cash cow. Sure, having a property manager at hand to help you with management would be sweet, but that’s an extra expense…. I’d be interested in getting into this if I were knowledgeable enough, but unfortunately, I don’t have time to study what it takes to be successful at this. At least, not right now.

I’d love to hear more about your good and bad experiences at real estate investing though, if anyone out there wants to share.

John DeFlumeri Jr November 12, 2009 at 11:11 am

You are so right. It’s not just a numbers game anymore. Buy and you’ll be holding it for a while. Some places need everything done. A “fixer-upper” might not be fixable, it may need replacement, costing more than new construction. Time to be careful!

John DeFlumeri Jr.

Financial Samurai November 12, 2009 at 11:22 am

Paul – You’re exactly right, and why I’m very enthusiastic when I read posts like this. It’s important for the dreams of those to crumble and capitulate. Everybody was a “real estate investor” during the boom.

My own simple post, “Note To Self: Buy More Rental Property” highlights what I’m doing right now. And what I’m doing right now is proactively looking to uncover future fortunes! 🙂

Silicon Valley Blogger November 12, 2009 at 11:30 am

@Financial Samurai,
Interesting… You’ve dropped several references now, and now I’m quite curious — where are you located exactly? 🙂

Goran Web Design November 12, 2009 at 11:49 am

South Africa had a similar housing boom, where loads of people were speculating and flipping properties for quick money. Unfortunately many thought this process would last indefinitely, and when the local property bubble burst it left many with second, spec properties that they couldn’t sell for a profit, nevermind covering costs, and hence a lot of people lost big bucks this side too.

Financial Samurai November 12, 2009 at 1:29 pm

SVB – We’re probably neighbors.! I live in one of these places: Atherton, Los Altos Hills, Palo Alto, Sea Cliff, Presidio Heights, Pacific Heights, Marina, Cow Hollow, Piedmont, Russian Hill, Mountain View, Hillsboro, Burlingame, San Mateo. 🙂

Where are you, and do you own? Sorry, I’m too lazy to dig the archives.

Silicon Valley Blogger November 12, 2009 at 1:39 pm

@Financial Samurai,
Okay that’s *highly* intriguing. I live quite close to a few of those locations you’ve mentioned (e.g. I live in the peninsula). Eh, I make it a point to try to meet local bloggers so perhaps one of these days when you aren’t too busy, you may be interested in a blogger meet up — with the Silicon Valley PF blogger gang. 😉

Financial Samurai November 12, 2009 at 2:54 pm

SVB – Sounds good! Shoot me an e-mail and visit my site one day. You’re on my blog roll actually just b/c you’re in the Bay Area 🙂

Who else is in the gang? Is there a secret handshake?

Manshu November 12, 2009 at 7:48 pm

Interesting to see that this whole discussion didn’t include anything about demand for rentals. Isn’t that a big part of it, or is it just a given that you will find renters easily?

Financial Samurai November 13, 2009 at 8:51 am

Manshu – If you buy your rental in a prime location, it really is a given. I’ve owned a rental in SF for 7 yrs now, and I just found a new tenant last year bc the existing tenant didn’t want to move!

In the middle of the financial meltdown this January, I had 30 couples want to give me a 7% rental yield on my rental. All you need is one. I should probably raise my rent by 15%, but I felt bad.

For landlords, this downturn is sweet bc rental demand skyrockets as less people can afford to buy. Landlords don’t care about principal values, they care about cash flow.


Silicon Valley Blogger November 13, 2009 at 10:47 am

@Financial Samurai,
No secret handshake, but we’ll be in touch with you! 🙂

Jackie November 13, 2009 at 11:39 am

I think your points about forgetting flipping and knowing the neighborhood are the most important. To me, “investing” has a long-term connotation to it; otherwise you’re just betting. (Although I like to bet sometimes too.)

I really want to get back into investing in real estate, but I’m waiting til I have cash in my hot little hands to do so. I figure there are good bargains to be found at anytime, so it’s not urgent that I jump in now.

Funny about Money November 15, 2009 at 4:39 am

I suspect that 7 percent is a little high. Here in Phoenix son’s neighbor is trying to rent his house — identical to my son’s — for $1,200, which would be about 7 percent. No luck so far.

Although a lot of real estate around here has gone into foreclosure, much of it needs expensive repairs. Most people who default leave an unholy mess, which often includes a ruined swimming pool. Some will steal and sell the appliances, hard-wired lighting, and plumbing fixtures. Even to fix up one of these wrecks as a rental, you’re looking at throwing $10,000 to $30,000 into it.

Jacob Christensen November 18, 2009 at 8:23 am

You’ve touched in an important point here. Many people come to our real estate office to ask about cheap places, thinking they’re really a bargain. In fact, if you don’t search well and go check the property yourself, you may really make a mistake. The money that you would save in a deal, you’ll spend paying companies to fix the problems on the house.

So you must pay attention!

Sandy November 18, 2009 at 9:02 pm

Great point. There are so many trashy beaters that ought not even be sold. That aren’t habitable. The vacant land itself is worth more than the property’s with the beat up old farm houses.

Houston Neighborhoods November 29, 2009 at 11:09 am

@Silicon Valley Blogger – Congrats on getting named to the most recent list of best blog posts via the Carnival of Real Estate.

I also think you make a great point about how stocks are a better pick as an investment for a large number of individuals due to the time necessary to make a profitable real estate purchase. There is still nothing better than owning property for developing a tax shelter for someone. You can also blow the stock market away when it comes to ROI with owning real estate, but it either takes lots of studying and work on your part or you need to find an excellent investment minded real estate professional with a honest and reliable vendor network. Which is not always easy to do.

I personally invest in both income producing property and REITs. My favorite class of REITs are the medical property specialists. If you index against the section of medical property REITs you can gain in excess of a 6% dividend and still have substantial upside potential on stock appreciation.

Jack G. March 16, 2010 at 9:01 am

I agree that it’s a buyers’ market, but the big banks are still fearful of loaning money even on their terms. And even when they do, it seems to take forever and a day to close the deal.

If it weren’t for private lenders who generally have less money than big public financial institutions, the housing market would be in worse shape than it is.

Naperville May 11, 2010 at 12:15 pm

What you said about flipping is true. Don’t be conned by a pseudo-realtor trying to dazzle you with promises that they are going to give you a winner home. Doesn’t really happen. Home prices are still declining, though there is some hope in some markets.

Jesmin October 18, 2010 at 1:30 am

Yeah …….. this is absolutely true that not all cheap houses are great deals; in fact, some are considered liabilities.

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