I’m in love with the idea of exploiting inefficiencies! I eat up books like The Four Hour Work Week by Tim Ferris, who talks about concepts like Pareto’s Principle:
(http://en.wikipedia.org/wiki/Pareto_principle). Pareto’s Principle states that for many events, 80% of the “effects” come from 20% of the “causes.” For example, 80% of a company’s profits might come from 20% of its clients. 80% of your joy in life might come from 20% of the activities you partake in, etc. Every year, I go through my landscape client lists and find the ones that fail to make the “20%” (for several benchmarks, including profitability), and I increase their prices a bit. After a few years of doing this, I no longer have an 80-20 scenario, it’s very close to fifty-fifty, which is ideal. (50% of our results come from 50% of our actions).
There are opportunities like this throughout our lives, personal as well as business. I’ve found a similar phenomenon in my real estate investing. Like I spoke of earlier, it’s common to categorize the quality of buildings into three basic classes: A, B or C.
Most landlords I’ve talked to make the most cash flow with class C properties. There are a few reasons they tend to spit out more cash every month. For one thing, they tend to be dirt cheap: You can pick up class C properties around here in 2014 for $10,000 – $20,000 per unit with many single-family homes going for under $30,000. They need work, but they’re very simple construction and by the time these landlords are done, they have “brand new” quality for less than $25,000 per unit. Class C rent prices are similar to class B, despite class C being far less desirable. I don’t know why for sure, but I’m guessing it has something to do with supply and demand. Most of the tenants who choose class C don’t qualify, for one reason or the other, for the class B areas, so class C landlords can charge a premium. That is to say they have a “captive audience”. So combine cheaper properties with market level rents, and you have a very profitable situation.
But with class C, you also have a lot more work: More evictions, more phone calls, and more complaints. Many of these tenants have to lie to the landlord even to get accepted, giving false references, false rental history, etc. Many of them have a handful of family or friends who will “pose” as past landlords, giving glowing testimony to unsuspecting landlords. Many are being evicted from one apartment at the same time they’re applying for their next. All in all, it can be a lot more hassle. The money’s good, believe me: We had two class C properties we bought as “experiments,” and we never had problems filling them. The problems crept in AFTER we filled them! In the end, we actually “converted” them to class B. We now have class B tenants living in our former class C properties. It was a lot of work. I wouldn’t recommend it unless you like a good challenge. And I despise a good challenge (in most cases), and I’m not ashamed to admit it!
What I discovered is that by buying B class properties and staying current with maintenance, you can make almost as much money (seventy-five percent) for less than half the work and hassle of a low-income investor. To me, this is one of the most magical things in business and investing. Not making the most money but making more money for less effort or stress. I’d rather make $75,000 a year working twenty hours per week than $100,000 working forty. Hands down. Not because I’m lazy or lack ambition but because it would drive me crazy knowing I’m working as hard for that final 25K as I am for the first 75K. I consider that almost sinfully inefficient and I’d rather spend that extra twenty hours researching ways to make another 75K vs. just working for the extra 25K. It’s all about “value” vs. just the income. This filter can be applied to anything that involves effort or currency, in exchange for an expected result.
For more SOOBI’s (Slightly out of the box ideas!) on real estate investing and life in general, visit Real Estate Rebel