Investing in physical real estate provides many benefits which include passive income / cash flow, appreciation, tax advantages, control and the opportunity to leverage your equity. However, there are many types of investment properties (e.g., high-end and affordable) to consider. In this blog post, we will discuss the upfront planning considerations as well as the pros and cons for high-end vs. affordable properties.
Disclaimer: Please note that there is no right or wrong approach as each investor’s objectives and preferences will vary. In fact, the decision may greatly be influenced by the amount of available capital. We will primarily be discussing residential apartment units and not other real estate classes (e.g., multi-family, single family homes, commercial, AirB&B).
Before deciding on a specific type of investment property, there is a significant amount of upfront planning work that is required to make an informed decision. Each investor should consider the following:
Choose The Right Location
Most seasoned real estate investors will tell you that picking the right location is likely the most important decision, perhaps, even more important than the choice of a high-end or affordable property. But HOW do you determine which locations are attractive and which neighborhoods will experience appreciation? This is often more of an art than a science.
While each investor may have different criteria for defining a “good” location, my wife and I have prioritized the following:
- Proximity to grocery store (e.g., Whole Foods or Trader Joe’s)
- Low Crime Rates
- 15-minute commute to work, restaurants, cafes, parks & entertainment
- Easy access to public transportation (e.g., trains, buses, water taxi / ferry)
- Infrastructure (e.g., Schools, Healthcare, Banks, Post Office)
Other analyses that may inform the desirability of a neighborhood or location include:
- Is there significant new construction activity? (May signal more demand than supply)
- What has been the rent growth in this area over the last few years?
- What is the average time on market for a listing before it is rented?
- Are there new local and essential businesses coming to the area?
- Are there new jobs being created in the neighborhood, drawing out of town residents?
The answers to these questions should improve your conviction of the location, and thereby, reduce the financial risk on your investment.
Additionally, the location will determine your competition in terms of the types of rental units that are available as well as the number of units that are renter vs. owner-occupied. By analyzing the inventory of the renter-occupied units, you will develop a baseline for the types of properties required to command different rental prices.
Well-developed neighborhoods and good locations are typically more expensive and safer bets for appreciation. For emerging neighborhoods, these locations may be less expensive to acquire properties but are riskier bets for appreciation. However, if you invest early and the neighborhood becomes highly desirable, then you may realize greater appreciation than investing in a well-developed neighborhood.
Research Your Target Renter Population
Profiling local renter demographics (e.g., age, household income, jobs) is important because this will directly inform who is your target customer for your rental and how much you will be able to charge in rents based on their income levels.
Are you targeting renters that are older or younger in age? The median age of a renter may inform location and space requirements (e.g., older renters may require more space for their families and locations with infrastructure more suited for families—parks, schools, daycare, medical).
Are you targeting renters with higher or lower household incomes? The distribution of renters at each household income level will provide an estimate for the number of potential renters and the monthly rents. For example, in NYC, there are a total of ~2M renters with only ~13% of renters earning over $150K in annual salary (see chart below). As a landlord, do you want to target the 87% of renters that earn less than $150K or the ~13% of high-income renters?
This decision of targeting higher income vs. average income renters is not straightforward. Here are just a few considerations:
- Do you want to allow roommates? (e.g., 1 bedroom split across 2 people)
- Do you want to allow guarantors? (e.g., parents responsible for rent if kids cannot pay)
- Do you want to allow tenants with government vouchers? (e.g., Section 8)
- Would you rather have average income renters rather than high income renters because they could be less inclined for turnover?
- Do you want to prefer high income earners from W-2s instead of those that have side-hustles that represent a significant portion of their income?
These considerations could expand or narrow your potential renter pool.
Additionally, shifting income dynamics plays an important role. According to RentCafe, millionaire renter households have tripled over the last 5 years because the cost to own in 2023 is more expensive in most markets vs. the cost to rent.
In major cities, the percent of high-income renters may vary greatly. For example, in analyzing RentCafe’s data, the top 5 cities with the most high-income renters include: San Francisco, CA; San Jose, CA; Seattle, WA; Washington, DC; Boston, MA. Bloomberg’s analysis of the RentCafe survey data by city is below:
As you can see, the percentage of high-income renters varies greatly and therefore, it is critical to research how jobs and incomes are changing for your market, especially with increased migration following the pandemic.
Higher income renters will likely desire newer units which may be more expensive to acquire while lower income renters likely will tolerate older well-maintained units which may be less expensive to acquire.
Understand Your Renter Preferences
Once you’ve decided your target renter profile, you need to understand WHAT types of amenities do these renters expect based on the rental price. As an investor, the difficulty is figuring out which amenities are must-have’s and will allow you to charge a higher rental price. Usually, the more amenities a building has, the more costly it is to maintain. To understand which amenities can command a higher rent premium, check out the “Balance wants vs. needs” section in our prior post The Ultimate Guide to Saving Money on Rentals!
For apartment buildings in major cities, most renters expect an elevator and a doorman. However, for high income renters with a strong presence of luxury rental and condominium buildings, the amenities package is becoming more extravagant and changing constantly. This makes it difficult to compete as the extravagant becomes the new standard amenities package! As a result, this ultimately drives up the acquisition price but also the monthly maintenance cost of the property.
To illustrate how extravagant and outrageous the amenities package is for new luxury buildings, below, we list examples of “lifestyle” luxury amenities targeting high income renters:
- Bright apartments with sunlight, great views and high ceilings
- Premium kitchen and bathroom appliances (e.g., Gaggenau, marble countertops, Toto toilets)
- In-Unit Washer / Dryer
- Fitness Center with Swimming Pool
- Sauna / Spa
- Recreational Facilities (e.g., Racket Ball, Tennis Courts, Basketball Courts, Rock Climbing)
- Smart Home / Automation
- Mobile Video Security
- Pet Spa and Grooming Services
- Extra Storage Space
Given the high cost of homeownership due to inflation, high mortgage rates, and low inventory, high income earners are becoming renters and allocating their capital to other investments. As a result, developers such as the Related Company and Toll Brothers are building more luxury products to target this group of renters.
As a small-time landlord, what amenities package will make your property competitive in your local market WITHOUT adding significant acquisition and maintenance costs for you?
Compare Pros & Cons of Properties
Now that we have reviewed how location, renter population demographics and preferences can impact your choice of the type of property, we will explore the pros and cons for each option.
High-End Properties
Luxury high end properties may appear attractive because of the higher rental income, quality of tenants and greater probability of appreciation vs. more affordable units. However, the upfront acquisition costs are much higher, carrying costs may grow faster than rents and higher likelihood of vacancy rates.
Pros
- Higher likelihood of high “quality” renter due to higher income
- Manage fewer units for the same amount of net operating income (e.g., net rent profit)
- Buying a new luxury development may require less maintenance / renovation vs. affordable units
- Greater opportunity for appreciation given newer building, more amenities, etc.
Cons
- Higher upfront acquisition costs
- Higher carrying costs due to taxes and maintenance
- Potential for greater vacancy rates given fewer qualifying renters
- Selling points of luxury amenities may quickly be diminished with competition
- Luxury rentals in the wrong location may not attract renters, regardless of the amenities
Affordable Properties
Affordable units have primarily lower acquisition costs, maintenance costs and may result in lower turnover of tenants. However, they may or may not command premium rents and may appreciate less than luxury rentals that have more modern amenities in the same location.
Pros
- Broader renter population given lower rents
- Lower rents will likely result in lower turnover rates, making them “recession-friendly”
- Lower upfront investment cost to acquire the property
- Fewer amenities imply lower monthly costs
- Opportunity to purchase more units given less upfront capital required
Cons
- Higher risk of lower quality tenant, which may result in higher risk of damaging the property
- Greater potential need for renovation as affordable properties are usually “old” buildings
- Lack of appreciation relative to buildings that are newer and more desirable amenities
- Potential for low net operating income because of lower rents and rent increases
- Limited differentiation vs. other properties beyond “price” / affordability
Final Considerations
Every investor’s situation is unique to their financial resources, investment objectives and their local market. Choosing between a high-end vs. affordable unit is a complex decision. For some investors, a “middle of the road” option may also be attractive. My wife and I prefer this option because this lowers our costs and still allows us to attract high income, high quality tenants.
As mentioned above, before deciding the type of property, investors should prioritize the following upfront planning considerations:
- Finding the “right” location
- Prioritizing your target renter population
- Understanding their preferences
Don’t rush the process as real estate is illiquid and typically requires a holding period of at least 10-20 years. Remember, multiple types of investment properties can make sense in your portfolio and we hope you found the pros and cons helpful!
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