Welcome to Passive Real Estate Investing. And another episode of Ask Marco where I answer your investing related questions.
So I’m going to cover about three questions here today on this Tuesday episode. And the first one comes from Raphael. He says, Hey Marco, I’ve been listening to your podcast and it has motivated me to start investing in condos. Why condos? I’m not exactly sure, but that’s cool. Let’s move on. He says I have already purchased one condo in the past year in a good location and still waiting for the turnover. Uh, I recently stumbled upon a new condo in a great location, good developer, and a good deal. The only problem is that it is a leasehold property being leased by the city. What he means there is the, a property is owned by the city and it’s being leased to whoever has the rights to that property. He goes on to say the developers had at least for 50 years but already used 10 for construction. That’s a long construction cycle and other delays. Now only 40 years remain. I plan to buy this property purely as an investment and to maximize rentals and I have no intention of living here. I’ve been reading about leasehold properties and saw that it does not affect the rentals.
Do you think it is a good idea to purchase the condominium? If I compute correctly, I will break even in 20 years. Well earning about $100 of passive income a month. This is deducted already from the monthly amortization from the bank. My fear is that I won’t be able to sell it to anyone if it only has a few years left after I maximize the rentals. Hope to hear from you. Thank you.
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Okay. I struggled to read that last paragraph here cause it was a little bit broken up so, uh, I apologize if I was choppy. Okay. Raphael right off the top before I even get into an explanation here.
If your break even on this property is 20 years and I’m not sure if you’re just looking at cashflow only or if you are looking at the potential forecasted appreciation in terms of equity growth in this property as time goes on, but regardless, either way if your break even is 20 years right off the bat I would say pass. The other thing that concerns me is that it is a leasehold property and I’ll explain that for the listeners here in a moment, but a leasehold property in only very rare occasions actually makes sense as a true investment and now let’s understand what we’re talking about here. You have two types of title or ways to hold property. There’s freehold and leasehold. Freehold is what most investors as in 99.9% of the time have and are used to, which means you actually own title, hold title. With a leasehold property, you essentially are leasing the property from the actual title holder, so you are the tenant.
Let’s just look at it that way. You are leasing from the person or company or city that owns the property and they are agreeing to lease the property back to you for 50 years or 99 years often with the option to renew but not necessarily true. My concern with a leasehold property is that when it comes time to sell the property, whether to another investor or someone who wants to be a homeowner, they may look at the title work and the paperwork and say, well there’s only five years or 10 years left. What do I do when that period of time runs out and now I need to negotiate or renew this lease. The looming cloud here is will that lease actually be renewed? This is where the fine print comes in. So I think it scares a lot of people off, so you need to be very careful about that.
I for one am not a big fan of leasehold and the other thing too is you have to remember that technically speaking you don’t own title to that property. You are leasing the land in the building or at least the land at the very least. On the flip side of that, when you talk about freehold properties, it is essentially looked at as the highest class of property ownership. You own the building and the land upon which it is built. It is yours and there are no payments, lease payments essentially for the ground rent because that’s what you’re renting is the ground or service charges or essentially what might be like HOA or homeowner association fees on top of that, you gotta look at this closely now from a cashflow perspective, $100 per month is okay if you are in a strong growth market where you are making up for what I’m going to call better cashflow potential in another investment property located elsewhere.
If you’re making that up because you are in a strong growth area and you expect that growth, in other words, price appreciation to continue for the foreseeable future. If the fundamentals and everything going on in that area and that suburb and that market are pointing in the direction that it’s going to continue to appreciate, then you could make an argument that $100 or so per month is okay. The only time you want to give up on cashflow is when you’re making it up multiple times over in terms of price appreciation because you just happen to be at the right place at the right time and you are in an appreciating market because there is real sustainable growth there, not from speculation, but actual growth from population, from job growth. The trends in the market are telling you that if you look at price graphs you will see that is what is happening on a sustainable basis.
Okay. That’s about it. The other thing I’ll make a comment about with condos that I do not like, and this is a problem in California, but in many other places too, condominiums often have a condo association, so you are essentially going to be paying a little extra or sometimes a lot extra out of your cash flow in terms of the HOA fees. Now in some places around the country, those HOA fees are nominal. They’re definitely under a hundred dollars and sometimes they’re only in the tens, twenties or thirties but in California, it is not uncommon to be well into the hundreds. The 400, 500 range even with condos and sometimes into the thousand plus dollar range, just depending on the neighborhood you’re in, so you didn’t mention anything about condo fees here, but that’s another thing that is probably eating into your passive income on that property without any other additional information.
I am going to guess that probably nine times out of 10 a deal like this is better left alone and you are better off looking at something else like a single-family detached home in just a quality neighborhood. All right, I hope that helps. Raphael. The next question is from Theresa and Theresa says, hello Marco. Thank you for all the helpful information you provide in your podcast. Thanks to this, I took action and invested in two rental properties last year. Congratulations Theresa. That is awesome. Planning to continue with this investment goal for the coming years. My question is regarding how Norada Real Estate or other turnkey providers and niche, which is a website grade. The different neighborhoods. For example, the two properties I bought were classified as a B per the turnkey providers. However, those neighborhoods are rated as C and C minus in Niche. I don’t know how the Niche determines this and it may be different turnkey providers using different criteria to grade the neighborhoods in their market. I will really appreciate your feedback on this. Thanks again, Teresa.
Teresa, great question. I’ve said this several times in the past over the years on the show that the grading system for neighborhoods is not defined in the industry. Now, most people understand what you’re talking about when you’re talking about an A versus a B versus a C. even if you want to get more granular and talk about an A plus versus an A minus or a B plus B or a B minus. So we all come to have learned what the grading system basically means in terms of the quality of the neighborhood, the demographics of the people in the neighborhood, the level of crime, the types of schools on a scale of one to 10 and what not. However, there is no formal industry definition and is that a problem? I don’t know. Maybe not.
You know we have our grading system, a different websites have their grading system. People generally talk about it in the, and it gives you an idea but it’s not a hard science. Let’s just put it that way. If you are being told one thing by the builder or the turnkey provider or even us about a particular property and you look on a website like Niche, which I’ve looked at and used but I don’t use on a regular basis at all. If the algorithm is different, which it would be probably 99% of the time, if that grade is close then it gives you a pretty good idea. All you’re doing is what I call triangulation. You’re just looking at it from different sources to see if it’s relatively the same. If it’s way off, then maybe you need to start questioning it and start doing a little bit more due diligence and digging in and looking at crime in the area, whether it be violent crime or just um, petty theft and other kinds of things.
The types of schools reviews online about those neighborhoods or that area. Talk to maybe a couple different property managers and realtors or agents in the area. They’ll definitely be able to give you feedback on that. But if fits close, don’t worry about if you’re looking at a B or B plus and everything is showing up as B or B plus, fine, let it go. But if someone’s telling you it’s a B and you’re looking in different areas and it’s showing up as a C plus or C minus, then yeah, that’s a pretty wide swing. So you have to understand that there’s no hard science to this, but you want to have a pretty good idea. B class neighborhoods typically are your middle income, bread and butter, you know, blue collar, upper blue collar type neighborhoods. It’s just for the most part a working class community.
You’re going to have a, you know, your Walmart’s and maybe your Macy’s and peppering of Starbucks and whatnot and those types of neighborhoods. It’s not going to be luxury or high end, like what you would find with the white-collar or upper middle-class incomes that you would find in a class neighborhoods. Nor is a B going to be something in the Cs where it’s typically your lower income, middle lower-income, little higher crime rate type areas that you know we call C class neighborhoods. So I don’t put a lot of weight on niche. In fact, I even went to the website to compare my neighborhood, which you know is kind of a more expensive neighborhood here in Southern California and everything shows up cross there. What is it, six twelve different categories as a, as a pluses and minuses with the exception of a one thing and that is cost of living, cost of living got hammered in, you know as a C minus or something like that.
Just because it is an expensive area to live. And because of that, you know, the overall niche grade was downgraded to something like an A or an A minus, I wouldn’t call it that. But if you factor in the cost of living, sure. You know, it drags it down. So their particular algorithm or the way they calculate their grades is based on these 12 factors. And then I popped in the zip code for the address of two of my rentals, just to see what it would say. And unfortunately you can’t put a specific address, you can only put a town, neighborhood or zip code so you can only get so granular with us. But I put in the zip code of two of my properties, one that’s in an upper-end area in Lee summit and it showed an overall niche grade of A, the only thing kinda got smacked on was uh, crime and safety as a C, which I question actually.
But again, they are looking at a large area because it’s zip code based. It’s not that granular. So, you know, I’ll say that that’s fairly accurate. And then I punched in another property, another rental that I have in a B class neighborhood. I would probably call that a B plus. But B is the worst-case scenario for this area. The street and Niche shows it as a B minus as an overall niche grade. And again, it’s getting docked on crime and safety and the public school system that got rated a C plus on public school. So it dropped it down to the low B’s, a B minus. I’ll say that’s fair. Overall, I would probably say this area is a B at worst and a B plus at best. So depending on where you’re looking and how big that zip code or that area is, you’re going to lose accuracy.
And again, this is just one algorithm or there are others. As a general rule of thumb, I like to look at how many people own their homes on that street and in that area. So the percent of owner-occupied homes in an area is not the only thing you should look at, but it is a telling thing. And so I like to see some definitely over 50% but if it’s over 60 70 great. If it’s over 80 that’s exceptional. You’re probably in an A type of neighborhood, a minus or better. So again, that’s just a general rule of thumb. That’s just one dimension as far as what you’re looking at with this. All right, so I hope that helps. I know this is a little bit confusing for a lot of people in terms of what does a neighborhood grade mean and what should I be looking at?
I like rules of thumb, but it doesn’t mean that you should follow the rules of thumb exactly, but as a general rule, I like to own rental properties in neighborhoods that are Bs, B pluses, A minuses. I find that those are the best bang for the buck. It’s a good balance or hybrid if you will, of appreciation, potential stability in the neighborhood, a large tenant pool and reasonable cashflow, so you got benefits on the front end and you got benefits in terms of longevity and the life of that investment. If you have more questions about this, I don’t know if you have an investment counselor here, but contact your investment counselor and they’ll dig into it a little bit further for you. All right, Theresa, I hope that helps. So I’ve gone 16 minutes here. I was trying to keep it to under 15 but I’m going to wrap it up, but I’m going to do another recording tomorrow with a couple more questions for this week. So I’m going to wrap it up here, but if you have a question, please submit that on our website. Click the Ask Marco button and I would be happy to either reply to you via email or better yet covered on the show. If you haven’t subscribed, you’re listening to this podcast. Go ahead and subscribe, share the show with other likeminded people. Just refer us or does visit us on iTunes. Leave us a rating and review and once again, thanks for listening. I will see you on our next episode.
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