Rental Property Tip #1: The Hidden Cost of Crime

The following is a post from our series of articles on How to Buy Your First Rental Property. If you would like to see more of these posts or learn about our upcoming video course, then please check out our course page.

If I could only use one metric to judge where I should buy a rental property, I would look at a neighborhood’s crime rate. The crime rate of an area can impact the value of the homes in more ways than you might know. Consider this list of the hidden costs of crime before investing in a high-crime area:

Crime reduces the long-term rental growth and appreciation rate for a property.

The added costs involved in living in a high-crime area cause property to rent or sell at a discount (when compared to the market average). Over the short term, the losses of foregone rent and appreciation due to crime might seem small; but over a 10–20 year time horizon, the costs can become substantial.

Tenants living in high crime areas are forced to live there and don’t choose to.

As soon as the economy recovers and those tenants obtain higher-paying jobs, they will leave the properties located in high-crime neighborhoods, resulting in a high Vacancy Rate. Maintaining a low vacancy rate is one of the most important aspects of real estate investing. How you go about managing your vacancies will determine how profitable your investments will be because each day your property remains unoccupied is another missed opportunity to collect rent.

Your vacancy rate is the amount of time in the year that your property remains unoccupied and isn’t collecting rent. Let’s say your property remains vacant for 2 out of 12 months. You divide 2 by 12 and multiply the results by 100, resulting in a vacancy rate of 16%. If you want to see how much that costs you, calculate your Gross Potential Rent for the year. This is basically the amount of rent you expect to earn from that property in one year. Take your properties’ monthly rent and multiply it by 12. So, $1,000 earned per month in rent, multiplied 12, will give you a Gross Potential Rent of $12,000.

Now take that $12,000 and multiply it by your vacancy rate of 16%. This equals a vacancy cost of $1,920.

Let’s say the average vacancy rate in your city is 5%, but in the high-crime area you invested in, the vacancy rate is 16%. Why does that matter? Well, instead of losing $600 per year in vacancy costs (5% X $12,000), you are losing $1,920 in vacancy costs—or $1,320 more than the city average. Over 1 year that might not seem like a lot, but over 10 years you’re looking at $13,200, which is more than a year’s worth of Gross Potential Rent for your property. That’s serious money.

Crime increases the cost of property management.

Properties in high crime areas will demand more of your property managers’ time, which will cause your property manager to charge higher fees for managing your property. Typically property management fees range from 6–8% of collected rent based on your market. For high crime areas, they will likely charge you upwards of 9–10%. On top of these higher fees and the added vacancy from having a house in a high crime area, your property manager will charge you up to a full month’s rent each time they have to find a new tenant.

Crime tricks novice investors into purchasing money pits with high rent yields relative to their property prices.

Many investors try to gamble in crime-ridden neighborhoods because the yields in decent neighborhoods are too low. It’s easy to think that a high-crime area in the out-of-state, tier 3 market is special and will slowly turn around. But odds are, that isn’t going to happen. In order for such a miracle to occur, the crime-ridden area in question would need to be sandwiched between great companies, top-tier universities, or technical institutes. Also, there would need to be an organized effort from city officials to fix the area through improved zoning laws, and an influx of capital to upgrade the housing stock in the area. Most high-crime areas outside of top-tier markets must compete with safer neighborhoods and more open land that’s ripe for development.

Thus, when you start analyzing areas to invest in, my first tip is to avoid the areas with habitually high crime.

 

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