Today’s question comes from Raj and Raj writes in and says, hi Marco. I am very inspired by your podcast. Very valuable information in each and every episode, he says, I’m taking the equity from my rental property in Los Angeles, and planning to invest out of state, working with your team has been very helpful. My goal is to get to 20 single-family residential homes in the next few years, so I can get the cash flow to be financially independent and retire from my nine to five job I currently have. My question is when I look at a house for sale, mainly when it is out of state, how do I assess if the location is an A, B, or a C, I can currently spend almost an hour by going to multiple local websites to assess income levels, schools, crime, and other characteristics before I’m guessing if it is an A or a C or a B. Is there an easy way to search by location?
Thanks for providing valuable education – Raj.
Raj, thank you for the question, it’s a good one, and one that actually kind of miss a lot of people. So the good news is that you can kind of figure this out with the information I’m going to overview for you here. I did actually cover this topic in a very early episode. Um, the fact that if I had to guess, I would say it’s one of the first five episodes of this podcast that I did over five years ago. I forgot the title, but essentially it’s about grading the neighborhoods. And I do talk about it a little bit here and there. I’ll give you a quick overview here, enough for you to essentially assess the type of neighborhood you’re looking at. And I will probably cover this topic again in greater detail in a future episode, not just for your benefit, but for everybody’s benefit.
So generally speaking, when we talk about the type of neighborhood we’re really referring to the grade of that neighborhood and vice versa. So we often call them A’s B’s C’s. And sometimes these, in fact, I jokingly take that as far as calling it an F neighborhood for a failed neighborhood, and that’s essentially a war zone. You don’t want to be there. In fact, I would never be in a D class type of neighborhood as an investment. And I would argue that you should try and stay away from C class neighborhoods, depending on your strategy. Certainly, a C minus, because that’s borderline what I would call, you know, war zone type neighborhood. But again, we’re talking about your capital and you’re investing it and the safety of that capital, but most people have a general idea of what we’re referring to. When we talk about an A versus a B versus a C class grade neighborhood.
Now keep in mind, some people will say it’s an A, B, or C property. And although you can talk about the property that way, and often what they’re referring to is the neighborhood or the area, not the property itself, but if you really want to be technical and specific and put an attorney hat on and really be analytical about this, you could actually grade a property as ABC or D if you wanted to, as well as the neighborhood, as an A or a B or C class neighborhood, but we’re talking about the area right now. And the other thing to keep in mind is that we’re talking about something that is mostly qualitative, not quantitative. So you can attach a letter grade, but you can’t necessarily attach numbers to these grades all the time. But because of this ambiguity, you know, we’re really having to have, or put together a general understanding or a basic overview of what they mean.
So let me give you a quick overview, by the way, you know, when I was saying there’s good news and bad news, well, the good news is that you can figure this out. The bad news is, is there’s really no one location or website that can just magically give you a letter grade by punching in an address. And if there is one, I’d like to know what it is, but even if there was, I can tell you that it’s not going to be completely accurate all the time. It’s just like Zillow’s estimate it has in many cases, a highlight level of reliability, but it’s never going to nail the exact market value of a property all the time. It’s just impossible. In fact, even Zillow admits that in, they’ll tell you from market to market, the accuracy can vary from as low as 50% to as high as 80% or more.
And that’s why they always give you a range as well. And they’re making assumptions it’s based on the condition of your property versus other properties as comparables. But anyway, back to these letter grades, you know, when we’re talking about C class and D class neighborhoods, we’re generally speaking about low income. Now, I just want to point out that you don’t grade a neighborhood based on income. It just happens to be a very highly correlated demographic factor when it comes to neighborhoods, but low-income neighborhoods are often the C and D class neighborhoods within a market. And you know, of course, that’s going to differ between, let’s say a San Francisco, which is very exciting to a market like Detroit, Michigan. You know, what’s expensive in Detroit is all true cheap in San Francisco, but each has their own scale of low, medium-high.
So whatever’s lower high price will be different in each market. And we’re talking relatively here. So a low-income neighborhood in one market is going to be specific to that market. It won’t apply to another market, but low-income neighborhoods generally have a larger portion of those residences on some sort of government assistance. Often that’s section eight housing assistance and the ratio, if you want to talk numbers, this has been my rule of thumb, essentially, but the ratio of renters to owner-occupied homes in those C and D class neighborhoods is often in fact, almost all the time, over 50%, but as often as high as 80%. So that means that the majority of the people that live in those neighborhoods are tenants. They’re renters. They’re not owner-occupied homes. There are exceptions to that rule. I’ve seen, you know, variations, but generally speaking, it’s high rentership.
And these neighborhoods are almost always the most affordable. In other words, lowest price areas within that market. And they will almost always have very high or certainly the highest rent to value ratios. So as a quick example, a $50,000 home in like the Midwest or the Northeast would probably rent for $800 or more a month. I mean, I’ve seen 800, 850,$900. I mean, that’s very impressive. Those rent to value ratios are very high, which means that your cap rates are high in your cash on cash returns are very high, but there’s a lot of trade-offs. So just keep that in mind. And anchors in these areas are schools, but schools without high ratings, of course, there’s going to be churches. Sometimes lots of them there’s going to be shopping, but you know, it’s typically low-quality stuff. You’re not going to find a lot of Starbucks for example, you’re not going to find expensive shopping. The strip malls are going to be basic necessities like your laundromat, corner store maybe a liquor store, that kind of stuff. They basically are anchors that meet the needs of the people that live there. Period.
So often investors will flip wholesale deals in these areas to other investors who are essentially going to fix these properties and then keep them as rentals. And that’s really the only strategy that works well in those neighborhoods. Now, moving up, you can move up into what I’ll refer to as your B grade neighborhoods. And these are the moderate-income areas. Now, these are moderate-income neighborhoods for that market, and they’re similar to low-income neighborhoods with one critical difference. And that is that higher homeownership. So while low-income areas have a larger portion of their residents on government assistance, the moderate-income areas have a larger portion of residents working in the blue-collar sector.
So a lot of blue-collar jobs for the people that live there, and this just helps to stabilize the neighborhood and make it more attractive as an investment area. Now, the ratio of renters to owner-occupied homes is far more balanced. It’s going to be much closer to 50%. So it might be 50 50. It could be 60% owner-occupied, 40% renters or tenants. And I like to break these, you know, C’s B’s and A’s into like your B minus B and B plus, and that’s just becoming a little more granular. I like to break it down that much, but not more than that. Now, area anchors in these areas also meet the needs of the people that live there, but there’s probably going to be more stuff that is geared towards people who actually have a little bit more money and are a higher income in those areas.
So they’re still well anchored. Now, these areas are also good for flipping homes like wholesale flips, but this is where it starts to get strong for buy and hold strategies where you buy properties that are good rentals and perform well. I happen to like the B class neighborhoods. They’re kind of a hybrid and the biggest bang for the buck. So you have some price growth. You have appreciation if that market is appreciating, but you also have good cash on cash returns and good cash flows. And I’m talking in dollar terms here now. So B class neighborhoods are good and they have a more varied selection of anchors. Now, when you start to get into the middle income, cause we were just talking about moderate income. Now middle income to upper middle income is what we’ll call A grade neighborhoods. Anything above that is still considered an A class neighborhood, but it’s more luxury end, not your just middle income.
So completely different in almost every way from low income and much of the moderate-income neighborhoods are these eight class neighborhoods or middle-income neighborhoods. And the biggest difference is the amount of homeownership and the type of employment. So most of the residents own their homes in these neighborhoods and are employed in either high-level blue-collar jobs or in various white-collar type of jobs and employment and middle-income areas are excellent for longterm holds. These are some of the most stable types of areas and neighborhoods that you can invest in. They just, it’s kind of like blue-chip stock versus, you know, a typical common stock. These are more of your blue-chip areas. They have stability and they’re not as likely to fluctuate over a long period of time, but often you’ll find the ratio of renders to homeowners are closer to 80% homeowner occupied versus 20% renters.
And I like to think that anything that has generally speaking again, it’s very subjective, but 70% owner-occupied and above is getting into your a minus type of neighborhood and above and middle-income areas. Like these have a greater number of anchors that meet not just the needs, but the wants of the people that live there. So keep that in mind. It’s not just about their needs now it’s about the wants. I think Starbucks, you know, that’s not a need, that’s a want, but the people have the disposable income to spend their monies on things like going to see’s candies or Starbucks or whatever it may be. And I just like to think of, you know, the three M’s what I call the three M’s and that is the malls, movies, and meals. So when you’re looking at an area that has malls, not just big malls, but some nice selection of nicer strip malls, movie theaters, and meals, you’re definitely now in these A class neighborhoods, I was going to say low A’s, but not necessarily.
So that’s a quick overview. And like I said, I’ll probably just review this again in another episode and kind of drill down a little further into home values, schools and crime, and how that relates to my investment philosophy and how investors kind of choose those neighborhoods. All right. Well, I don’t know if I answered your question, but there’s really no website per se, that you can just go and look up those characteristics, but there are a lot of websites that you can gather those characteristics and really assess what type of neighborhood it is. You know, we obviously do that with the properties that we post on our website, which again, I’ve said it before, it’s not a hundred percent of everything that is available or in the pipeline, but for the amount of properties that we can take the time to post on our website, which can be a lot of times we will actually assign a letter grade to it.
And that’s just based on the stuff that we just talked about, you know, with obviously more weighting towards certain factors. Anyway, Raj, I appreciate the question. I think a lot of people ask this type of question, so hope that was helpful for you, and with that for everybody else, if you have a question about investing real estate or finance, let me know, just go to passiverealestateinvesting.com or AskMarco.com. They take you to the same place right now. Remember to subscribe, share the show with your friends, family, and other likeminded people.
Thank you for listening. And I will see you on our next episode.
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