Christopher Miller, MBA | Specialized Wealth Management
Originally Appeared in Apartment Management Magazine
This month, I would like to talk about real estate investments that I personally avoid. I’m not telling you to avoid them; although I certainly do. If you do want to purchase something from this list, hopefully I’ll provide some useful questions for your due diligence process.
I have heard student housing described as “great – because you’ll get higher rent from students.” The higher rent part may be true; but remember that investment real estate is priced based on the income that it produces. An investor is therefore already paying more for this higher income. So much more that, in my experience, he’d be better off paying less for a non-student building; and earning a higher return on his equity in the process.
The higher rents commanded by student housing projects can actually be a liability. Let’s say that market rent for a 2 bedroom apartment in a given city is $1,500 per month, but that similar apartments near a university rent for $3,000. Since the student housing owner paid more for his property; both owners can have similar returns on their equity. The student housing owner’s success, however, is tied directly to the neighboring university. If university enrollment drops drastically, or a large new on campus dorm is built or large new off campus properties are built; the student housing landlord could see demand for his units – and therefore his rent – drop drastically. In a worst-case scenario, he is stuck with the market rate of $1,500 per month and renting to non-students: a bad situation if he paid for $3,000 rents.
As a rental real estate owner, I can’t imagine owning property that becomes 100% vacant every year;
yet this is exactly what student housing landlords sign up for. Even if you don’t end up with tough-on-units tenants; that’s still a lot of repainting, cleaning and re-tenant-ing that needs to be done every summer. All that extra work ends up costing extra money too – which comes directly from your bottom line.
One exception I’ll make to my student housing rule is for properties that “really aren’t student housing.” Let’s say that a property is comprised of 50% students and 50% non-students. This tells me that rents are close to a market rate – why would somebody who wasn’t a student (a bus driver, for example), pay a premium to live in student housing? I would see such a property a<, an opportunity – one in which I could eventually convert the property to student housing, then sell it to someone else who will pay a huge premium for those higher rents.
I have found hotels to be completely dependent on our national economy’s health. A few years ago, every hotel in the country saw their bottom lines sh1·ink dramatically during the “great recession.” This same thing happened after the September 11 te1Torist attacks – travel decreased dramatically, and most every hotel in the United States saw their income drastically reduced.
Although few people seem to remember; our economy tends to hit a recession every IO years or so. While owning properties long commercial leases or apartments in growing areas can insulate you against these downturns – similar measures to reduce risk don’t exist with hotels. They do, after all, have very fast tenant turnover so 100% occupied can become 10% overnight. I’ve watched what happened with hotels during the past few recessions, and that’s why I choose
to stay away now.
Properties in Resort Areas
Properties located in resort areas are third on my “things l avoid” list; for reasons similar to those above. A shopping mall, for example, in a ski resort town is susceptible to threats from a poor economy in reduced sales and higher vacancies. If shopper traffic is reduced even further by a decline in tourists, these problems felt by tenants are magnified. The mall in this example suffers a “double whammy.”
Although long-term leases in commercial properties can mitigate risk in resort areas – if that lease expiration strikes along with a downturn in the economy; you could be renewing at a deep discount – or worse – not at all. Since these resort areas are entirely dependent on tourist traffic – your fortunes as a landlord would be, as well.
I know a lot of smart investors who own rent-controlled units; but it’s not for me. I prefer to operate with as little government interference as possible; especially when that interference is limiting how much rent I can charge. As a landlord, I know that buildings need maintenance and occasional upgrades to stay in good condition repairs that must be sipped if the property’s cash flow won’ t allow them. This will eventually degrade the condition and value of my property possibly more than the decline caused by limited rents. Also; remember again that investment properties are valued based on the income they generate. If the government is limiting my income; they are also limiting my prope1ty value.
As I said at the beginning of this article, I won’t tell you not to invest in any of these four categories. If the price is 1ight; there could be good deals anywhere. If you are seriously considering one of these properties; make sure your business plan addresses the pitfalls that I’ve highlighted in this article.