Many investors are dabbling in real estate to diversify their portfolios and build wealth. It’s a great strategy if you know how to find rentals and keep them filled. When you’ve examined the processes and determined that you’re ready to dive in, you’ll look for a property that you can turn into a rental.
As a new investor, you’ll soon discover that good real estate is all about location. If you’re ready to invest, finding a property that will make a great rental is the first step, so what’s the best location?
There may be conflicting advice on this front. Some say that if you want a profitable rental that’s low maintenance and always filled, it’s better to purchase in a nicer neighborhood. But others say that the best rentals are found in low-income neighborhoods because there are fewer houses for sale.
It’s hard to say exactly which areas are best to shop for rental properties because markets vary. However, you should weigh the pros and cons first.
The Benefits of Renting Out in an Affluent Neighborhood
There are a few benefits of an affluent neighborhood that are worth considering – although it’s important to note that these potential benefits are just that: potential. In other words, there’s no guarantee that these benefits will occur; rather, it’s more likely that you’ll experience the following in high-income neighborhoods versus low-income neighborhoods:
- Better Tenants: Typically, tenants in an affluent neighborhood will have fewer problems than those in a low-income neighborhood. They’re less likely to have a criminal history and bad credit score as well.
- Fewer Missed Rent Payments: It’s likely that you’ll have fewer missed rent payments because your tenants are less likely to experience money troubles. Again, this isn’t a guarantee, but the chances are higher.
- Less Maintenance: Ideally, a tenant who can afford a rental in an affluent area might require less maintenance because they take better care of it. The property will likely be newer as well, demanding less maintenance.
- Fewer Theft of Damage Incidents: Affluent areas tend to experience far less crime, so you’re less likely to have your appliances stolen or your property damaged.
The Disadvantages of Renting Out in an Affluent Neighborhood
There are some glaringly obvious disadvantages to renting out in many affluent neighborhoods that might make you shy away from these areas, and most of them have to do with money.
- Significantly Smaller Pool of Renters: The clearest disadvantage is the higher inventory or rentals compared with a smaller pool of renters. There are simply fewer renters in affluent areas. This will make filling your rentals more challenging.
- More Expensive Investments: The rental costs will be expensive as well. Homes and multifamily properties are significantly more expensive in affluent areas because they appreciate well and are in good shape. Therefore, it will take longer and be more difficult to make back your investment.
- Bad Tenants Still Exist: As mentioned previously, an affluent area is not free of bad tenants. You can still find tenants who look good on paper but damage the property or don’t pay rent. You might also get difficult tenants who are constantly making requests and requiring unnecessary maintenance.
The Benefits of Renting Out in a Low-Income Neighborhood
Typically, investors find that it’s more financially advantageous to rent out properties in a low-income neighborhood. Here are some of the biggest benefits of doing so:
- Affordable Properties: As a general rule, purchase a rental property with good enough margins that you can break even within seven years; you should be able to pay your mortgage back within that time. Then, everything you bring in on the property can go to maintenance and/or profits. This makes properties in low-income neighborhoods ideal! It’s not uncommon to find a great rental for around $50,000—a fraction of what you’d pay in a high-end neighborhood.
- Great Investments: Typically, rentals in a low-income neighborhood have a higher return on investment. You can usually find affordable homes and multi-family complexes to purchase in low-income neighborhoods, which means that your mortgage will be low, and your rent can be set at a high margin.
- Multiple Rentals: It’s much easier to have multiple sources of rental cash flow going at a time when you’re dealing in a low-income neighborhood. Because the margins are higher and the costs are lower, you can easily diversify your portfolio and quickly increase your profits.
The Disadvantages of Renting Out in a Low-Income Neighborhood
But money isn’t the only factor to consider when investing in property. There are several major disadvantages to renting out property in low-income neighborhoods that you should know about:
- Higher Risk of Bad Renters: There’s a higher risk of getting bad tenants when in a low-income neighborhood. They might struggle to pay rent, damage your property, break the lease agreement, and refuse to move when you evict them. This calls for better tenant screening practices.
- More Property Damage and Theft: It’s not uncommon to hear stories of major theft, like brand new appliances being stolen and replaced with decrepit units. It’s also more likely that the property will be damaged and kept in bad repair because the tenants don’t care. Crime and vandalism could also occur.
- Rent Delays and Missed Payments: The odds are higher that a tenant is living paycheck to paycheck, so they’re more likely to make late payments or miss payments altogether.
The Verdict: Low-Income Properties Are More Profitable
As a landlord, you have a responsibility to weigh the pros and cons of renting out a property in any neighborhood. You can identify market trends and analyze the types of tenants and risks that enter both low-income and high-income neighborhoods in your city. In many cases, the results will be typical, but there are many atypical neighborhoods out there, so you’ll want to do your due diligence.
If you’re in a typical area, the low-income rentals will be significantly more profit-friendly than those in higher-end neighborhoods, even if the risks are higher. As long as you do your due diligence and keep a fund for damages and theft, you can usually mitigate losses and keep on the upside of your rental.