From Worst to First: The Magic Formula

So, how do you take a dumpy neighborhood and make it nice? The formula my wife and I conjured up has worked tremendously well for us. So much so, that most people just shake their heads and say "I couldn't do that. I don't know how you did it." I have heard that way too many times and it really bugs me. Anyone can do what we have done. It just requires a clear vision of what you are going to do, a budget, and fortitude. The truth is, my wife and I stumbled upon a formula that is not new. The Housing Geeks at the Harvard Joint Center for Housing Studies have probed this issue in depth. Here is what our Ivy League Scholastic Achievers have to present to us (color and additional labels added by me):This chart explains everything about fixing run down neighborhoods. The secret? Capital improvements in property with the resulting skilled tenants that pay higher dollars for them. The Q* line is the line where skilled tenants will pay more for a property than unskilled tenants. There is a certain quality of home where this change in rent dynamics happens. Inversely, if the home is lower quality, the skilled tenants willingness and bid to rent the property drops off tremendously while the unskilled tenants willingness and bid to rent remains high.

This chart perfectly describes the dynamics going on between high-income and low-income housing. At a certain point, regardless of the niceness of the home, unskilled tenants cannot afford to pay more for a property. Their income is tapped out at a certain level, no matter how nice the home. The skilled tenant has more income and therefore can afford a significantly higher rent for the nicer homes.

This process also shows how you can have substantial changes in quality of neighborhoods in very short distances. The lines passing through the Q* inflection point between these two groups are pretty steep. Therefore, the change in quality of neighborhood can be pretty abrupt from location to location.

A good example of this is the before and after snapshots of my fourplex. I inherited tenants in the fourplex when it was purchased. The upstairs tenant was a stripper by trade with multiple evictions, felonies, and a drug habit. She paid $550 a month for a 3 bed 1 bath Unit. The problem was that she was in jail so much she could barely make the rent if at all. The down stairs tenants were drug users with a knack for painting graffitti on the walls. They paid $500 for a 2 bed 1 bath basement unit. After the $35K that it took to resurrect the building, the 3 bedroom was rented to an accountant and a surgical technician for $610 per month. The basement unit was rented to college students for $495. Fortunately the building was purchased for such a price that it made sense to make these repairs.

Prior to the repairs, skilled tenants would not even look at the property. The property landed at the very left end of the chart. By fixing it up, the property moved to nearly the inflection point. Again, the numbers on this particular project made it worth the while. By renting to skilled tenants, management has been significantly easier.

If you are thinking about fixing up homes in Ogden, plan on spending 10% to 20% of your purchase price on capital improvements. Buy the place right, and you will be rewarded handsomely.