Whether you are buying a car, real estate or even just a bottle of wine, people are always looking for the best possible deal. It may go without saying, but people love bargains. It may even be safe to say that people covet the real estate bargain most of all. A property listed below $50,000 may seem too good to be true. However, that is not always the case. Upon closer inspection, the property may need more work than meets the eye. While some properties are well worth their low sticker price, others may require so much work that their value isn’t worth the purchase. If you are on the fence as to whether or not an inexpensive property is right for you, here are some pointers to help with the decision:
1. Location: Location is one of the first things you need to look at when attempting to determine value. If there is no demand, a cheap property will do you no good. You should never make an opinion about a property without researching the area. Some seemingly rough areas can make great rental property candidates. Some locations that would appear to have excessive demand are much more bark than bite. An inexpensive property doesn’t have to be in a rough area to lose value. If you get a property in the middle of a rural area, it will have the same impact. Retail sales and rentals are all about the demand that is created. You can change almost everything about a property except for the location. If the location is poor and the demand is low, even the lowest purchase price will not make the property appealing.
2. Condition: If someone is willing to sell you something well below market value, there must be a reason for it. With inexpensive properties, the usual culprit is the condition the property is in. You may be able to get a property for $40,000; but if it needs another $60,000 to make it functional it had better be well above average prices for the area. Not only will you need to have the capital to pay for the improvements, but you will need to allocate the time, effort and resources. Even if you decide to rent the property, you need to find the balance of appropriate improvements and market rents. Also, you need to do your homework and make sure that there was nothing you missed. Inexpensive properties are typically either older or neglected for years. This leads to many problems that you may not be able to see at first glance. Foundations, sewers and other hidden areas can be expensive problems to fix that you may not have budgeted for. Before you entertain an inexpensive property, you need to know everything about its condition.
3. Return on investment: To maximize your return on investment, you need to spend money. You don’t need to make your rental the best one in the town, but you need to modernize it. This will increase your total investment and require the rents received to be higher. If you do not put the right work in, you will not see the demand you expected. Lower demand usually equals a lower rental price. If there is tremendous equity in the property, you can live with only realizing a small monthly profit. However, if the equity margins are slim and there is limited cash flow, you are not getting a great deal with the property – even at a reduced price. Let your numbers tell you what kind of deal you are getting. Only once you factor in all the expenses and what you need to outlay on a monthly basis, can you make your decision. Don’t be blinded by the cost of the property. Look at the big picture and factor in everything you will spend.
4. Resale price: Before you commit to any property, you need to have an idea of your exit strategy. This is especially the case with inexpensive properties. Your margin for error is typically much smaller with these properties. Too many people think that their rehab work will yield a greater return than the market dictates. Your improvements can be perfect, but buyers will not overpay if the location is poor. Don’t look at the highest recent sale for the area, look at the lowest. Prospective buyers will take this approach when they consider buying. If you can only break even renting for a few years, there should be a good amount of equity in the property. This calls for you to be updated and realistic with the exit strategy. Before you buy, have a good idea of what you can sell for.
Inexpensive properties will often come with boom or bust potential. There are good deals out there if you know where to look, and what to look for. Don’t be blinded by the thought of a perceived good deal. Purchase price is always important, but there are many other factors to consider as well. Evaluate the location, condition, repair estimate and exit strategy before making your decision. Sometimes a great deal on the surface may end up being more trouble than its worth.
Justin Lee Thayer is Lane counties expert in market analysis for real estate investors. Call Justin @ 541-543-7287