Why I Stopped Buying C-Class Assets
John Larson and the Real Estate Cowboys talk passive income real estate investing.
Hear new episodes every Sunday morning at 8 a.m. The Cowboys talk past experiences and the reasons for not getting into the C-Class real estate market for single-family homes.
Keep the #CowboyCoffee hot while listening to John, and the Cowboys talk about how to #BeACowboy and earn passive income in real estate.
Announcer: Have you thought about becoming financially free through real estate investing, but don’t have the time or knowledge to get started? Welcome to the Real Estate Cowboys podcast. Each week we discuss passive income investment opportunities in the red-hot Texas market. John Larson and the Real Estate Cowboys will show you how to leverage their team to build wealth in real estate through passive investment opportunities. And now here’s John.
John Larson: Hello everyone, this is John Larson with another episode of the Real Estate Cowboys. This week we are discussing something that I am very, very passionate about, why I stopped buying C class investment properties. And I have so many reasons why, but the main reason is, to be frank, they just did not work. They just came with way too many problems, way too many issues and just did not give me the passive experience that I was looking for. I’m already busy enough with my active turnkey business, with my own active retail flips that I do in the markets that I invest in. The last thing I want is problems with my rental properties because I already have enough problems and issues and things that I need to solve on a daily basis with my active investment model. When I first got my start, I’m sure if you’ve been listening to the Real Estate Cowboys or follow American Real Estate Investments, you know, I got my start in Detroit, Michigan, actually buying renovating and managing C class investment properties. And I quickly found that they just were not giving me the experience that I was looking for. And so many of my investors that come to American Real Estate Investments, they’re really looking for good cash flow. Although in today’s market, like we’ve discussed, cash flow is becoming pretty compressed due to the rising interest rates and the rising prices. That’s just the nature of the market today. But you know, I’m looking for good cash flow, but my investors are looking for good cash flow, but they’re also looking for a passive experience because I have a lot of investors that invest in Dallas or in Kansas City or in Houston or Waco is an area that I’m now really, really hot on. They want to invest in these markets, but they live in California, they live in Denver, they live in Phoenix, they live in Michigan, wherever it may be.
And so it’s very important to them that they’re receiving a passive experience as well. And, and I think with real estate, you know, everybody’s looking for a passive experience and trying to reap the benefits of the six ways that real estate pays you, which we discussed a couple of episodes ago and I think the only way you can really do that is you have to avoid these C class properties or at least, you know, don’t buy a heavy portfolio of C class because like I said, more often than not the property is going to have some issues, whether it’s an eviction, a high-cost turnover. Like, I have an investor now that purchased property from us in Indianapolis. Um, it was a C, C minus home. He had a bad turn, you know, upwards of $5,000, I think after the security deposit, it’s a $4,500 turn because the tenants just did not take care of the property.
And I tried to explain that to my investors that, look, this is some risk that you’re going to be running into. You know, when you deal with C, C minus, D class homes, they attract C, C minus, D class tenants that have C, C minus, D class jobs that have C, C minus, D class credit scores and more often than not these properties are managed by C, C minus, and D class property management companies who are not holding these tenants accountable, who are not training these tenants to take good care of the properties and pay rent on time. So on and so forth. You know, and that’s where a lot of the trouble starts to occur. And not only that, now this person’s going through a $4,500 turn. The property is now sitting vacant. A $4,500 turn doesn’t get done in a week or two. It could take much longer than that.
And then you’ve got to get the property back on the market. You know, hopefully, it’s not winter. If something like this happens in a market like Indianapolis, Detroit, Cleveland, you know, any cold weather state, because then you run the risk of an extended vacancy as well. And so we’ve talked a lot about, you know, not chasing a paper yield, “do not buy the lies,” I like to say, you know, anybody can doctor up an Excel document to make it look like a property is going to be a great rate of return, you know, but in actuality when life really happens, and you do take ownership of this property, you start to realize that the property and the tenant that it attracts, it’s a lot more troublesome. And then also that property sits vacant for an extended period of time. Let’s hope it doesn’t get broken into in that C, C minus, D class neighborhood.
And so really when I am telling my investors to buy more of that high B to A class inventory, I’m not saying it because you know, it looks prettier, I’m saying it because those are the properties that work and I’d rather take a lower stable amount of cash flow than a high peak, low valley scenario that C, C minus, D class properties present. That’s all I’m saying. And then also we want to encompass all the six ways that these rental properties pay you. We want the appreciation. Well, guess what? C class properties don’t really appreciate, and we’re about to get into that, you know because they’re traded on cap rate, and there’s no retail home buyers that want to buy in those neighborhoods. There’s no retail home buyers that are willing to, you know, get in a bidding war with somebody and overbid over the asking price to win that property. That’s not the way it works. These are all rental neighborhoods, 90 percent, 100 percent rental neighborhoods. That is where I’ve found too many times in my career that I’ve ran into trouble every time I went and tried to produce something that the investor wants, and not what I know that works. I’ve gotten in trouble, and we’ve had investors. I’m not gonna sit here and tell you that all the investments I’ve ever done has been great. I just gave you an example of an investor who invested with us in a low C neighborhood in Indy and didn’t, it wasn’t having the best experience right now, not to say that we can’t right this ship and get this thing back on track, but they’re just, the problems are more common, right? I don’t have high costs turns on my A class properties, and it’s..it can happen, don’t get me wrong, but it’s very rare that it happens.
It’s all about mitigating the risk involved with being a landlord and owning real estate. It’s a very, very difficult to mitigate risk at a C class property. It just, so in my career, my partners and I, we’ve sold over, purchased, renovated and sold over 70,000 single family homes in 12 different markets across America. So we have a lot of experience. We know what works, we know it doesn’t work, you know, and in the Detroit market, the C class properties, they were just weren’t, they weren’t performing, you know, in St Louis and in Kansas City, in Indianapolis, the C class, low C to D properties were just not working. You know, it was like a 50/50 almost crapshoot whether the property was going to provide a successful passive experience for the clients or it wasn’t. And even if it performed very well for one to three years, eventually there’s going to be some problem that can become detrimental to the investment and it’s the tail that they grow like I’ve discussed like I’ve talked about, and that tail starts with an eviction. Then a high class turn, than an extended vacancy. Then a break-in. Then more expense to renovate it. Again, so on and so forth, and the tail keeps growing to the point where it’s just, it’s hard to cut off and then you as an investor, you want to sell the property because you’re not having a good experience. And C class properties are notorious for providing bad experiences. For my clients too, where they just decide, you know what, I’m not going to do this anymore, I just want to sell it, and then it’s like good luck trying to sell it for the price that you bought it for because your, your exit strategy is really just another investor. And what investor is going to buy a property that’s having issues or that needs to be renovated and pay the same price that you paid for it. They’re just not, you know?
So I want my investors to avoid those bumps and bruises. Now there’s some investors out there that don’t mind the risk. Maybe they’re just more investing in real estate for the tax shelter and the tax benefits. And that’s okay. You know, we had an example of an investor who said, you know, I own a lot of properties. He was looking to do a 1031 exchange like we discussed in last week’s show. He has $500,000 that he’s ready to unload into some properties and 1031 into some properties. But when he got on the phone with a member of my team, you know, through our qualification process in our discovery process where, you know, we try and get to know all of our investors. We found out he’s only really investing in Detroit, in Albuquerque, New Mexico, you know, and I don’t know what type of economic benefits there are or what type of economic growth or is in Albuquerque, New Mexico. I’m not very, that’s not a market that’s on my radar. I know Detroit really well. Um, I know that there’s not many people moving into the city of Detroit. I know there’s more people moving out than moving in. And Albuquerque, not sure like I said. From an economic standpoint, how that’s, you know, a good market in order to mitigate risk and keep property’s occupied consistently. Where a market like that can provide low vacancy because once again, those properties do not work unless you have somebody willing to rent it from, you know. But he said that those are the only areas that he’s investing in right now. And I can see why, because those are the areas that are able to give you a high rate of return on paper.
Those are the areas of the U.S., those are some markets like Alabama, their are cities in Alabama, you know, they’re able to provide that high rate of return on paper, but it doesn’t always work out that way. And actually, more often than not, it doesn’t work out that way. You know, through his discussion with a member of my team, uh, he told her that, well, I have a very, very large portfolio to where I can, you know, I can accept the risk that’s involved with C class properties. He already understands that there’s a good portion that aren’t going to work, but you know, he owns such a large portfolio that more work than don’t work. And that’s, that’s a good strategy if you have that type of money, um, to where you can buy 100 doors or more and just have that portfolio going.
And I would say that you know, you can probably have more, let’s say out of 100 homes, maybe 60 or 70 are performing at any given time, so the other 30 to 40 percent that aren’t performing, the ones that are performing outweigh the ones that aren’t, but not everybody has that type of capital and appreciation and things like that, were not big in his mindset, which makes me feel like he’s really looking at building real estate portfolios and things like that as a tax shelter, for the tax benefits. For the investor that wants a passive experience, and for the six ways that real estate pays you; appreciation being the main one and appreciation being the one that makes you wealthy. OK, cash flow doesn’t make you wealthy. It doesn’t until you get to a certain amount of properties and you’re able to, you know, pay loans off and get the data off of them and get these things cash flowing at their highest and best.
They’re not gonna make you wealthy off the rental income. You know, they’re gonna make you wealthy off the tax shelter that they provide, the appreciation. So on and so forth, that’s what’s going to make you wealthy. And targeting the right markets that are on a growth curve. Okay? Getting in early on markets that are growing fast, targeting the right market that’s on that upward trend and capitalizing on that. That is what’s gonna make you wealthy, you know, going back to C class assets, back in another session I was purchasing properties for 5, 10,000, you know, as low as 5 to $10,000 up to about 40,000 and putting 20 to $30,000 for the renovations. And we were selling these properties. I was, we’re holding some, we are selling some to investors at a slight markup. You know, our fee for producing this turnkey property. And the homes would sell around for around $60,000 to $80,000 to the investor. And you know, at that time I wasn’t producing anything that would sell for over 100K. And you know, in the Detroit market, I would probably say that the median home value at this point is probably about $200,000. But coming out of the recession, it was probably lower than that. Maybe more so around like, yeah, maybe 160, 170. So you know when you’re producing that asset that you’re selling at 60 to $80,000, $80,000, that’s a 50% decrease in what the actual median value is. And we’ve discussed on the show quite often that I really recommend not to buy too far below the median value in any market, and usually, with C class, you’re going to be running into that situation where you’re buying well below whatever the median value is, which increases your risk. If you were to look at this on a graph, you would see a curve where, you’d see the curve as the value goes down, okay, and the rental rate goes down, the value of the property goes down.
You will see on the other end, another graph where the risk is going up on an upward trend. It’s almost common sense to somebody that’s invested in real estate consistently and has a good track record and a long track record investing in real estate. Anybody will tell you the lower grade the property, the lower rents for, the more risk is going to be associated with it. And the common risks, which are the evictions, the high cost turns, the maintenance of the property. C class buildings tend to be older homes as well, which means that they just run into more maintenance issues and from what I’ve seen with C class properties, the margins there for the renovation, they aren’t as large for an A class home or anything like that, and they don’t need the type of renovation that an A class home does. Um, so you see a lot of lipstick rehabs, what I would call fresh paint, you know, fresh vinyl flooring or fresh carpet, you know, jazzing up the landscaping a little bit. Jazzing up the exterior a little bit, but nothing too major, you know, because it doesn’t have to look that great to rent out for 600, 700, $800 a month. It just doesn’t. It doesn’t have to be a palace. And so those ones, just like I said, they tend to just break down a little bit easier. The materials that are used for the renovations are a lot cheaper, and that stuff just doesn’t withstand as many turns no matter what anybody’s going to tell you. And what I’ve found, and this is me owning C class properties myself, what I found, the maintenance was a lot higher and, and it was more common. It was more frequent with those type of tenants that C class properties attract. It just seems like when people are less responsible, they don’t care for things as much.
You know, the rents that I was doing at that time would probably range from $600 and $900 per month. So they were hitting that at least 1% rent-to-price ratio, which was more common back in 2011, 2012. You could really hit those numbers and you can kind of still hit those numbers today in many C class markets. But that’s not a great rule of thumb to identify what a good investment property is. You know, if you ask anybody, Grant Cardone, you know, anybody in that investment property, you know, a good cap rate or a good rule of thumb to buy an investment property should not be strictly on a number and a rent-to- price ratio. It needs to be based number one on location.
Location is number one. Then from there, it needs to go to what the median value is in that market. And so anytime I’m analyzing markets, number one, looking at location, and then I start looking from a macro level, what’s the median value? What’s the median rents in this market? Um, where are the good true middle class neighborhoods where the neighborhoods that I should avoid, um, I’m looking at economic drivers, what businesses are moving in, what jobs are being created, are more people moving into the market year over year? Then moving out, what has the appreciation been? What are the days on market for properties? Is that trending? Is that going down? Days on market is going up. That stuff I look for, you know, and then when it gets to actual like micro level, you know, then you really start diving into the neighborhoods, and you start looking at what areas have maybe better schools than others, you know, what areas are going to be able to attract the best tenants, things of that nature.
And if you start analyzing markets based on that, and obviously you want to put your money into affordable market, we don’t want to put our money in California, in San Francisco for a rental property or San Diego or LA or Sacramento or San Jose. Those aren’t good areas for rental properties or Phoenix, Scottsdale or Denver. Even in Texas, Austin for example, these are all areas where you just have higher priced inventory. So you know, we want to make sure that we’re not paying into the property every month, right? We want to provide some cash flow each month, but I’m just saying don’t get tricked into this high amount of cash flow on a spreadsheet thinking that the investment is going to be great. And then some get rich quick scheme that’s not gonna work. If you’re chasing a property based on that, you’re already going to be running yourself into problems.
That’s the wrong way to look at it. And if a passive experience is important to you, then don’t buy C class assets. Passive experience is very important to me. I don’t have a lot of extra time available. I’m flying to Belize this week to meet with investors down there with Keith Weinhold from Get Rich Education. We have a large group of investors coming down to see what’s going on in Belize and Placencia. You know I’m going to be out of the country. I have a young daughter. She just turned one. I run a couple different investment companies. I don’t have time to deal with the problems that come with C class investments. So passive income, a passive experience, truly passive income and a passive experience is very, very important. We’re going to take a quick commercial break here. When we get back, we’re going to talk more about why I stopped buying C class investments. I’m trying to help you out Real Estate Cowboys, trying to help everybody out here, so you don’t make the same mistakes that I did, so we’ll get more onto that topic. We’ll talk more about that when we come back.
And welcome back to the Real Estate Cowboys. This is John Larson. We are talking about why I stopped buying C class investments, and I talked a lot about, you know, buying the lie. Don’t buy the lie and don’t buy a property based on a paper return or yield. You know, it’s very easy, I’ve said time and time again, to make a spreadsheet look like the investment’s a home run, but in actuality you know, the risk is just far, far greater. And so I tell a lot of my investors all the time, you know if my A class property is only generating $100 a month in cash flow, take it because it probably really will attract or garner $100 a month in cash flow. Now, if you’re comparing my A class property to let’s say a C class property, wherever Kansas City, St Louis, Detroit, Indianapolis and that property is going to give you $300 a month cash flow.
Okay, so you’re thinking to yourself, well that’s an extra $200 a month, and that’s an extra $2,400 a year, and I’m sure your return because you’re buying a lower priced properties, so less money out of pocket, and what is return based on? it’s based on your purchase price, your money out of pocket, and then your return of money coming back in on that investment. And so I’m sure that obviously with C class investments, they’re lower priced, so that rate of return is going to look higher. But that extra $200 a month that you’re getting in cash flow on a paper. What is that going to matter? If the property just comes with so much more risk? $2400 a year is actually not that much money. If it’s just rolling back into another property due to extended vacancy, where your paying the note and you’re paying the expenses, the taxes, so on and so forth.
The lawn maintenance, while the property is not occupied. Right? So, so really what is that extra $200 a month at $2,400 a year if the likelihood that you’re going to be rolling that money back into the property due to an extended vacancy or due to a lot of maintenance or due to a high cost, high cost turn turnover? Like I discussed with my client in Indianapolis who’s having a little bit of a rough patch right now with one of his homes because the turn bill came back at $5,500, and you had a thousand dollar security deposit on hand. So he’s $4,500. So he’s going through a $4,500 turn and the property’s sitting vacant right now. So it’s like a double whammy, you know, it’s a double whammy to the pocket book. And so that’s just what you have to take into consideration. That $2,400 a year between a C class and an A class property is not that much money if the C class home’s just going to come with more risk and the likelihood that you’re going to have to roll that $2,400 back into the property anyway, $2,400 or more is a lot higher with that property.
So we have to be very, very, very careful when, when analyzing these homes and just understanding, you know, that this one is going to come with more risk than the other and in many cases a lot more risks. So another reason I stopped buying the properties is they were just difficult to manage. You’ve got to always think about what type of tenant is this property going to attract. And with C class investments you’re going to be attracting tenants, that make below median income for your market. So that’s another thing that I pay attention to in the market is what’s the median income for the area? You know, $50,000, $60,000, $70,000, you know in Dallas it’s gotten close up to $70,000, you know, so I’m targeting people that make $70,000 or families that make $70,000. The median household income for my investment properties. I want to target that true middle class because I know that the likelihood that my tenants at that median income are going to pay rent on time and consistently, I know that likelihood is far greater.
And the same goes for when you deviate too far below the median value in the market. Well, when you are going after tenants that make far less income than what the median income is for that area, that’s also gonna run into some trouble just because they don’t have the consistent income, the consistent jobs. Um, job turnover is far greater with those. You know, these are tenants that aren’t at a salary position; they’re probably on an hourly position. It’s just not secure income. Well, that’s how evictions arise. You know, these tenants in my experience, it always seems like there’s a very good chance that they’re paying late, and your property manager’s always chasing them down for rent, which will eventually result in evictions because you’ll have tenants that say, well, I’ll pay half now and then half later, but then you never get that half later, you know, and now here we go.
We’re filing for an eviction. We’re filing a judgment. You know, the main thing with evictions that you want to look out for, obviously an eviction means that now you have somebody living in your house that’s not paying rent. And some states are more or less; I should say, landlord friendly than others. California is not a very landlord friendly state, and there’s other states in the union that are not very landlord friendly and Michigan’s actually one of those as well. Whereas Texas is a very landlord friendly state. You know you don’t pay rent, you can get the tenants out very, very easily by taking them to court if needed. Simply show the judge, here’s the proof, defaulted on rent. That tenant can be out within 30 days. I’ve seen other markets, cold weather states like Michigan. It’s in the middle of the winter. You can’t evict them because it’s freezing temperatures, you know, in my opinion, I want to avoid those type of markets.
I want to avoid that class property, I want to avoid that class of tenant because I don’t want to have to go through an eviction because nothing makes me more upset than, with the single-family rental model, than when I have, you know, a delinquent tenant that I have to evict still living in my home and it’s taking me months to get them out of there, because now I’m paying the bills for that tenant to stay there. That’s not paying me. That’s not a very good feeling, you know, that’s what we want to avoid. That’s a major reason why I don’t like to invest in these C class properties as well. Like I said, very difficult to manage. Very, very difficult, you know, and I’ve also found that the tenants who make lower incomes are usually the people who damage your home while they’re living in it.
You know, if a person can’t be responsible enough, here’s a good response to the rule of thumb. If a person can’t be responsible enough to handle their finances, what makes you think that they’re going to be able to take care of your home like it’s there’s? They’re not. I ran into a lot of trouble with this with section eight because it’s government subsidized housing. You know the government is paying a large portion of the rents. Well a lot of investors are like, wow, guaranteed income, but it also makes the tenants care less, even less it seemed like, about the investment because they weren’t using their hard earned money to pay for rent, and they also knew that in order for the owner to keep that section eight voucher, the owner had to do yearly maintenance, routine maintenance of these properties, so they can break things, and it would still fall back on the owner.
The owner would have to go in and inspect the property every year. Make sure that the property is up to standards for section eight. If the tenant was rough on the home, you really have no recourse. It’s going back to the owner. Hey, you want to still keep this property under section eight, you have to do all these repairs and with C and D class homes, really a lot of times all you can rent out two is section 8 tenants, so to lose a section 8 voucher can be very detrimental to you because there’s just not a lot of market tenants out there. They’re all looking for the section eight property. You know, the majority are on section eight, so you really have to be careful about keeping that voucher intact. You don’t want to lose that.
And then as I said, more often than not, my C class properties had higher turnover costs and higher maintenance requests. It just seemed like I would have almost every month a maintenance request on my C and D class homes. Whereas my A class high B, B class properties, I was rarely having maintenance, and it was just, it was very difficult for me to find a professional management company with the proper infrastructure to manage C class homes. You know, most professional management companies have a minimum rent requirement that C class homes, not me, You know, a lot of management companies I know won’t manage anything under a thousand dollars and won’t manage anything under $1,200 because they don’t want to start delving into those areas and those properties where it’s just too troublesome, and it doesn’t really even make sense to manage them for the eight to 10% management fee that they’re charging.
It’s not enough money for them to even to make it worth it. Most of the time. What I’ve seen is, if you’re purchasing a C class investment, you’re going to have to lean on a mom and pop type of operation to manage the home. You’re not going to get like a really big professional management company with the proper infrastructure in place to professionally manage hundreds of thousands of homes. You’re dealing with more of that just mom and pop type of operation where more problems are going to start to arise, and these people don’t have the staff or the infrastructure in place. These companies don’t have that to really professionally manage these properties. So that’s another thing that you really, really need to consider and I think we talked about this and I am going to have some more episodes coming up, talk about property management and things to look for, things to look out for, questions to ask property management companies when you’re interviewing them, you’ve got to thoroughly vet these companies out to make sure that these are the right people to look after your investment.
This is your hard earned money that you’re putting into homes and if you’re buying properties outside of your own backyard and relying on a management company, to look after them. I mean, that really is the most important thing. It’s not only buying the right property in the right neighborhood that’s going to attract the right tenant. I mean you want to set your property management company up for success, and you can do that by buying better properties, higher-end properties, higher class properties. But then also you know, if you’re going to buy, as I said, these C class homes or any home, the management company, if they don’t have the proper infrastructure in place and things of that nature. And I’ve just seen that many companies that manage C and D class properties don’t have that. It makes it very hard to manage them. Very, very hard, and that’s where the big problems can start to arise.
So number three is like I discussed, the properties don’t appreciate. My most successful investments have been purchased in markets with high population growth and job growth. They’ve also been purchased in neighborhoods where the owner or owner occupants want to live as well. Not just renters. You know, I really like to target more owner occupant type neighborhoods than rental neighborhoods, because I know those neighborhoods are more desirable. They’ll stay desirable years to come. It’s usually because there’s good schools there. It’s a good neighborhood; it’s, it’s an area where people want to live. So my rule of thumb has always been, if you have people that want to buy homes in these neighborhoods for themselves, then there’s a very, very good chance that there’s going to be a lot of people that want to rent those properties as well. And these are the neighborhoods where owner occupants will be willing to pay at least market value, if not more than market value.
And the factor being the desirability of the neighborhood that drives up the pricing. Those are the areas I really like to target, right? Because retail buyers don’t care what the property runs for, they don’t care what the cap rate is, they just wanted to buy that property so they can move in with their family. And that sets our investors up for a solid exit strategy too, because you know, if you need to sell this house, let’s say you do go through a tough situation and the property’s vacant for a long time or you have a really bad turnover, and you’re upset, and you just decided, you know what, make an emotional decision, you want to sell it. I’m just; this isn’t working out for me. Well wouldn’t you want a property in a neighborhood where you could easily hire a broker, you could easily for sale by owner of this property and sell it to somebody that’s not going to care what it’s going to rent for? That just wants to move into the house? They’ll fix it up. They’ll be more than happy to buy a property in a neighborhood that they want to live in and get it at a slight discount and put some work into it because this is a home that they’re gonna they plan on living in for years to come, but their kids in that school district, you know, if your only exit strategy is to sell to another investor, that’s a bad investment in my opinion. It doesn’t give you multiple exit strategies. It gives you one. If that one fails, then you’re stuck holding the property or that exit strategy results in the buyer only wanting a discount to take it off your hands, well then you’re losing money and that, in my opinion, is not a good investment. You know, owner occupants don’t want to buy and C and D class neighborhoods. Only investors typically buy there. And this causes prices to stay stagnant because investors buy on rate of return. They’re traded on cap rate, these homes. And they’re not willing to pay over market value for properties. How many investors do you know or you yourself go in and say to a turnkey company, I’ll pay over market value for that home to win that bid. No. Investors always want to buy at least at market value, if not below. That just doesn’t work. But in a retail neighborhood where owner-occupants want to live, they’re willing to pay. My mother just bought a brand new home in this suburb of Detroit. She was having the most difficult time trying to find a home. She just finally got one. She had to offer $20,000 over asking to win the bid. I wish that investors were willing to do that, but they’re not because it’s all based on numbers and rate of return and no investor’s going to pay over $20,000 for a home that’s an investment property.
That wouldn’t be a good investment, would it? You know, you have to really take that into consideration. Desirability is a very, very huge factor and appreciation is the number one way I believe that real estate makes you wealthy. Buying properties in markets on a high growth, upswing, getting in at the right time and riding that appreciation wave and then potentially looking at a refinance, cash out refi or selling the property down the line. It does not mean it needs to be a long-term hold scenario. Making that equity tangible and putting that equity in your pocket, bank account, taking advantage of the 1031 exchange that we discussed last week, and keep deferring those taxes out. I really tell investors all the time, you know, cash flow is great, but really it’s just pocket change. I mean, $100, $200, $300. Hey, $400 a month. Is that really gonna make or break you? $400 a month. It’s usually going to mean you’re buying D class properties, which like I said, the likelihood that you’re going to keep generating that $400 every month is very, very low. Okay? So please keep that in mind. So really quick. Let’s take a break when we come back. A couple more reasons why I stopped buying C class investments. So stay tuned. We’ll be right back on the Real Estate Cowboys.
And welcome back to the real estate club cowboys. We are talking about why I stopped buying C class investments and this, like I said, is a topic that I’m very, very serious about it, very passionate about. And I have conversations with investors every day about this, you know, and like I said, it’s this show, not to bash C class homes, you know, it’s not to say don’t buy them, I’m just saying this is why I stopped buying them because passive experience was important to me and C class, D class properties are anything but passive. And so another thing that I experienced with C class homes was high vacancies. And as I said earlier, C class properties are going to come with the highest vacancy risk. This is due to the low income tenants that they attract and the desirability of the areas. And if you’re also buying these properties in a market without a lot of population growth, that’s another, you know, high vacancy sign, you’re going to be assuming high vacancy, extended vacancy.
Now, for example, if you bought a C class home in Dallas, you probably have still a lot of turnover, but you wouldn’t really necessarily have extended vacancies because almost 150,000 people have been moving into this market year over year. A portion of that hundred and 50,000 people that move into the market are looking for a C class property. They can only afford a rent under $1000 a month. So you still have new blood moving into the market that’s looking for C class rentals. Now you buy a C class home in a market like Detroit for example, or a market like Indianapolis where there is not a high amount of population growth, you’re already running the risk of high vacancies due to a lot of turnover and eviction, so on and so forth, but then you’re also increasing the likelihood of an extended vacancy, especially in winter months when the market is very stale and stagnant.
Low-income tenants are a greater risk to lose their jobs or miss rental payments. That’s a fact. This will result in evictions, as I’ve said. Some markets in America are very tenant friendly like we discussed. Michigan wasn’t the most landlord friendly state that I experienced. California was not the most landlord friendly state that I’ve heard from California investors who have done 1031 exchanges and have invested in Dallas or investors just from California that want to put their money into rental properties. And Texas makes sense because the market’s more affordable, but there’s still a ton of jobs here. This type of stuff, evictions and having an eviction in a state that’s not very landlord friendly will result in a lot of heartache, expenses, and loss of revenue for the investor. Like we said, distressed neighborhoods are also less desirable, and this is going to hurt your chances to find new tenants quickly when the property does go vacant. So lot of lot of vacancy and the opportunity for high vacancy is common in C class neighborhoods, in markets with not a lot of high population growth and job growth that are driving people into the market.
The last one is the high maintenance costs, which we talked about. The lower income tenants are more likely to beat up on your home when they’re living in it. I’ve just seen it. My investors have seen it, you know, we still do manage some properties that I would call C realm back when we were selling C class homes. And those are the ones where all the problems come from. Uh, just to be quite honest, I don’t see evictions. If I do, it’s very rare on my A class properties. Um, it can become a little bit more common when you dip into the B realm, but when you really get into that C realm, you are talking about tenants that make far below the median value or median income in the market where you’re investing.
Like I said, if they don’t have the best jobs or the best credit score or you know, they’ve proven that they can’t take care of their own finances. What makes you think that they’re going to take care of your home? And so that is something that you really, really need to pay attention to. With A class properties and higher-end properties, now you’re dealing with tenants that are higher earners, that have better credit scores, that you know, take better care of things, and which usually results in better care of your property. And it’s just in my experience, have had to pay more money on maintenance and turnovers of C class properties than any other property class. And these repairs can be so high that it could swallow up an entire year’s return or more, like I said, the extra $2,400 on a spreadsheet where it makes you look like you’re making an extra $2,400; the chances you are going to have to put that $2,400 or more back into property are so, so high. Higher than you think. And so those are, those are the five reasons why I really stopped buying C class investments. And it’s just a really geared my attention towards A and high B properties. And that’s why I like to present only those opportunities to my investors. Because really at the end of the day, I just want my investors to have a successful experience because I hate taking the phone calls from my investors who are unhappy. You know, it’s nothing more disappointing to me then when a property is not performing for someone. And so all I’m trying to do is just decrease the likelihood that I get those troublesome calls. I’m trying to decrease the likelihood that, you know, my property managers are going to be running around ragged because this home is just have an issue after issue after issue after issue.
We just don’t want that type of inventory to manage, and we don’t want to put our investors in that type of position; especially my investors that are looking for a truly passive experience. So here’s another good rule of thumb. Here’s what we do at our management company. In order for the tenant to qualify, one of the ways that they qualify, they have to make at least three times the monthly rent gross. So for a property that’s C class, that rents for $800, that means a tenant only has to make at least $2,400 per month. Okay? And at $2,400 per month, that means that that tenant only makes $28,800 a year. If that was in the Dallas market where the median household income is almost $70,000 or might be at $70,000, you’re talking about somebody that makes well below the median income. And so the average income for the U.S. currently has about $55,000 per year; $50,000, 60,000 somewhere around there. Which means that these tenants earn over $20,000 less than the nation’s average. I mean that should just spell out. That’s common sense that these tenants are just not going to be as responsible, you know, or they’re working positions where it’s an hourly wage and the the chance that they get fired or quit or lose their job for whatever reason, down economic time. So on and so forth. They’re there without a job, and it’s gonna be hard for them to find another job, and they’re living paycheck to paycheck, and job loss and things like that are very, very. They’re the number one reason why C class tenants, you know, go through the eviction process. You know? They’re on a very fixed income, very low income; car breaks down, job loss, usually can result in an eviction. On the flip side, rents for A class properties are, you know, $1,800 on average, which means this tenant would make $5,400 per month, which means they make $65,000 per year, pretty much. Which is right in line with the middle-class median income in the Dallas market at least, and is actually above the US average of about $56,000.
You’re targeting tenants that are above the average, above the nation’s average. Well, that should make you feel pretty comfortable that you’re getting better tenants in the home that will pay their bills consistently, right? That care about repairing their credits or care about saving up to buy their own home and so they don’t want to do anything to damage that. Like mess up your home and have you come back through collections trying to recoup that money if they don’t pay it or go through renovation and have that on their credit. So that’s what I found personally.
And so another thing about A and C class properties, the difference between an A and a C; I’m just trying to go from one broad spectrum to another. C class homes are generally going to be older properties. They’re going to be 1960s builds and below. They’re going to be in distressed lower-income neighborhoods, as we talked about. The neighborhoods are going to be heavily occupied by renters. They’re gonna be smaller homes, and they’re going to be renovated with lower end renovations. That’s pretty typical for a C class property. Now at A class, you’re going to have newer homes usually built within the last 20 to 30 years. You’re going to be in middle to upper middle class, highly desirable neighborhoods. Uh, you’re going to be in neighborhoods that are occupied primarily by owner occupants. They’re going to be a little bit larger properties, and they’re going to, they’re going to have middle of the road to high-end renovations when you’re dealing with that high B, A class property, more durable renovations, better tenants, better neighborhoods, better exit strategy, or more diverse exit strategy, not just one. That’s what you’re going to get with A class buildings, and so like I said, I’d rather take… I have properties where I make $50 to $100 a month net cash flow, but I have great tenants where I have no turnover, no issues. The property’s been leased out long-term, been very passive and they’ve been paying my principal balance down for me monthly. When I’m looking towards the future for when that property’s completely paid off and my options available to me at that time where I can just collect my highest amount of cash flow because I’ve now eliminated my principal and interest payment. Now let’s think about my return. Okay. I put $50,000 down to buy a $250,000 home and then with my initial $50,000 investment; now I’m cash flowing at over a thousand dollars a month. Wow. Great return. 30 percent in some cases, and then if I want to sell the property for $300,000 or just $250,000 for the same price that I bought it for? Well, that’s now a $200,000 profit. That’s pretty awesome. And that’s what these A-class investments can do for you. And so I hope that you found this information useful. Um, like I said, this is all just coming from one investor to another. I’m just explaining what I found worked for me. Um, and I’m just trying to educate my investors on how to really get that passive experience. Because if you listen to other podcasts, you listen to other “gurus” across the nation, they’ll all tell you that rental properties are passive. You know this is passive income. The word passive is thrown around like the word hello in this industry. The fact of the matter is that the further below the median value you purchase these investments, the more risky, the more problems you’re going to have and the less passive experience you’re going to happen. So if you liked what you heard about this or if you liked what you heard on this podcast about why I stopped buying C class investments, please go to our website RealEstateCowboysDFW.com. If you’re interested in learning more on how to get involved with higher, a higher b class, uh, A class properties if you’re interested in learning more on how real estate can pay you in all the six ways that are available. Um, if you’re interested in learning more about leveraging or maximizing your IRA or 401k to where you can get high fixed rate of return on your money through a private lending option through self-direction, or if you’re interested in learning more about vacation rental opportunities because you think of yourself, Hey, I’m about to retire, I am retired. I want to put my money to work in something that I can use as well and live out my years in paradise when I want to. And when I’m not, I collect some money. We can give you all these options and explain more about how you can get involved in these options. Just go to RealEstateCowboysDFW.com, put in your information, get on our list, or download our free passive income starter kit to learn more about all these opportunities as well. For those of you who just don’t know which route you want to go just yet, maybe you’re new to investing. Take our investor quiz on RealEstateCowboysDFW.com, and find out what type of passive investor you are. A lot of cool stuff that you have the website. Thank you all for tuning in this week. We’ll be back next week with another great conversation, more content and more education on the Real Estate Cowboys radio show. Have a good week.
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