Finding Profitable Investment Property

I was in court the other day filing an eviction and I met a guy doing the same thing. He was complaining that his girlfriend gets mad at him for losing money in his properties. That got me thinking about how different people look at profit. To me it seems simple, but maybe that's because I think like me. Maybe I really don't get it?

So lets look at this guy, Tim. He has a bunch of duplexes and three families in Milwaukee. Since he is having a hard time managing these properties, he is considering selling out and buying one big property that will let him pull a steady income. Tim tells me that if he sold well, he would have $200k. His plan is to take that and buy a single 4 family. He is considering two different buildings. The first is in a decent area, looks nice, and is well maintained. It is selling for $300k. The second is similar, but it has a 4 car garage! The garage is great he tells me (this is Wisconsin and a garage sure beats scraping ice and snow off your car when it is 10 degrees below zero and still dark out!). This one is selling for $350k. What do you think? Sounds like a good move, right? Upgrade to a single building, only have one lawn to mow, and only 1 building to visit, not to mention it is in a nicer area of town.

I'm not so sure though. That is the same price I paid for an eight unit building. I asked Tim how much extra rent they are getting for the garage spaces. "None," says Tim. Next I asked him how much rent was - $625. Tim was still excited about the garage! I asked why, and he looked at me like I was some idiot who never scraped ice before. I asked again, a bit more obvoius: "rent is 625 at the one with no garage right? And rent is still 625 with a garage?" Tim is still looking at me funny. "So, I see why the tenants benefit, but what do you get from the garage, how much extra money do you make for the extra $50k?" Tim's look changed, he stumbled a bit and said, "I guess that is how you should look at it, like a business." YES!!

That seems obvious to me, but it took 15 minutes to get my point across to Tim. What about harder questions? I also asked Tim why he didn't put that $200k into a $1 Million property. Instead of $2500/mo he could be getting $8k/mo or more. But is it that easy? I didn't push Tim on that one. From his perspective, the leveraged money is money paid to the bank rather than himself. I think of every property as a cap rate. For me, a 10% cap rate in a bad neighborhood is always better than a 6% cap in an upscale neighborhood.

I know there is more to it than that, but that is my focus. Tim was right about one thing - maintenance is easier in the nice neighborhood. Less damage, fewer evictions, and less time spent removing graffiti. To me, that should commmand a higher rent too though. How much is that worth? Tim is getting $2500/mo versus my $4800/mo for the exact same purchase price.

Until the market rents increase in Tim's area, he will be subsidizing them while I profit. When looking at real estate as an investment, the money needs to add up. It isn't about pretty fences or garages unless the rent is higher, or vacancies are lower. Do you know that? Does your real estate agent?