Investors in Dayton, Ohio, provide template for converting distressed homes into cash-flowing rentals.

Not commonly known as a housing hot spot, Dayton, Ohio, has become the market of choice for real estate investors Scott Stuber and Tyrone Velasquez.

The Denver-based married couple employs an investing strategy in which they purchase distressed properties at a discount and perform quality rehab to convert the homes into cash-flowing rentals that are still affordable for tenants in the West Dayton neighborhoods where they invest.

“Our goal is to find a decent deal that requires some work, some investment in it, that’s a good price,” said Stuber. “Something that once we have the initial investment in, and our repair costs … we can be cash positive on our costs within three years’ time.”

An Auction.com analysis of 199 U.S. counties with at least 10 online auction sales of bank-owned (REO) properties in the first seven months of 2020 found many often-overlooked “highways and hedges” markets like Dayton at the top of the list in terms of potential rental returns.

The analysis calculated a potential rental cap rate using the average fair market rent for a three-bedroom property from the U.S. Department of Housing and Urban Development (HUD) and the average sales price for REO properties sold on the Auction.com platform—and then factoring in 40% for expenses such as property taxes, maintenance, and property management.

Top Rental Markets
According to the analysis, the top five counties with the highest potential rental returns were Comanche County (Lawton), Oklahoma; Broome County (Binghamton), New York; Trumbull County (Youngstown), Ohio; Peoria County, Illinois; and Madison County, Illinois, in the St. Louis metro area. Montgomery County, Ohio, in the Dayton metro area ranked 37th on the list with a potential cap rate of 15.2%.

Stuber and Velasquez have been able to achieve even greater rental returns in the Dayton area because they are buying in down-and-out neighborhoods where the REO properties and other distressed properties are selling at an extremely low price point.

“We have bought houses on auction for as low as $6,000, and as high as $26,000,” said Stuber, noting that the homes the couple buys usually need extensive rehab. “For the most part, we put at least as much in the rehab as the property cost.”

Stuber grew up 60 miles north of Dayton and was familiar with the city, which was hit hard by the 2008 Great Recession, further removing an already down-and-out Rust Belt market from its former glory as an auto industry powerhouse.

“We found there were a lot of foreclosures in the market,” he said, explaining the research he and Velasquez performed in trying to identify which market to target with their investing strategy. “So I flew to Ohio for about four days and looked at a few properties on Auction.com to get a list ready. Did some investigating, looked at the properties, drove by to see what the condition of the properties are, what the neighborhoods are like. We actually ended up buying all three properties within about three weeks.”

Velasquez, who grew up in Florida, wasn’t immediately convinced that Dayton was a good market in which to invest. But after due diligence and spending time in the city, he quickly changed his mind.

“Once we started doing the research, we found that the Cincinnati-Dayton area is just growing … there’s other companies that are moving in. …they have the Air Force base, they are doing a lot of things with the city,” he said. “Once … I came here I was like ‘Oh wow, it’s not as bad as I thought. They have these rivers coming through, they have this beautiful skyline.’ … And I was sold.”

Rehab-and-Rent Investors More Confident
Nearly one-third of real estate investors buying on the Auction.com platform (31%) said their primary investing strategy is the rehab-and-rent approach Stuber and Velasquez employ, according to a buyer survey conducted by the online distressed property marketplace in April 2020. That was compared to 66% who said their primary investing strategy is rehab-and-resell (fix-and-flip).

Rehab-and-rent investors like Stuber and Velasquez were much more likely to be confident in their investing strategy than rehab-and-resell investors, according to the survey, which was conducted in April, shortly after the declaration of the COVID-19 pandemic. More than half of rehab-and-rent investors (64%) said they planned to continue acquiring as many or more properties in 2020 as they had in 2019, while the reverse was true for rehab-and-resell investors. More than half of those fix-and-flip investors (59%) said they planned to decrease their acquisitions in 2020.

Rental investors were likely less shaken by the pandemic-induced crisis because their investing strategy is not as subject to volatility in home sales and price appreciation as the rehab-and-resell strategy. Furthermore, the potential rental returns available in often-overlooked markets like Dayton provide plenty of cushion, even if rental rates decline or vacancies increase.

Rush to Online Buying
Since they began buying in Dayton back in 2017, Stuber and Velasquez have been focused on buying at online REO auction, something more investors are turning to given the pandemic-triggered foreclosure moratorium and growing competition for properties listed on the Multiple Listing Service (MLS).

The April 2020 Auction.com buyer survey found that 61% of investors selected online REO auctions as their top acquisition strategy, beating out inperson foreclosure auctions, off-market, and MLS.

The April buyer survey represented a significant shift from a buyer survey conducted just two months earlier, before the pandemic, in which inperson foreclosure auction was the top acquisition strategy for 49% of investors, the most of any acquisition strategy. In that survey, only 29% of investors said online REO auctions were their top acquisition strategy.

Turnkey rentals represent another acquisition source, particularly for more passive real estate investors who don’t have the time or ability to perform their own rehab like Stuber and Velasquez. Turnkey rentals also represent an investing strategy: in the Auction.com survey, 6% of buyers said their primary investment strategy was to rehab and resell to other investors.

Demand for those turnkey rentals has increased since the pandemic hit, according to Kathy Fettke, co-CEO of Real Wealth Network, a company that connects passive individual investors—most holding full-time day jobs—with turnkey rental properties.

“Our sales have not slowed down. Prices have not come down. Rental applications are up. Rents are stable or increasing,” said Fettke in a May interview. “Our teams do not have enough inventory to meet demand. And we were only doing property management updates to keep our members informed of rent collections, but they begged us to start showing properties. So we have.”

With the extensive rehab they perform, Stuber and Velasquez are in effect creating turnkey rentals for their own portfolio.

Happy Tenant, Happy Landlord
“We expect the house to be a mess when we get in there, and we can just go in and make it beautiful,” said Velasquez, noting that it’s a nice surprise when properties are not as bad as anticipated. “What we’re finding with a lot of these houses is what they need is a lot of cosmetic work, and that we can do ourselves. … We haven’t had any huge surprises or huge gotchas.”

Because Stuber and Velasquez do most of the rehab work themselves, they’re able to keep the rents affordable for people living in the lower-income neighborhoods where they invest, even while generating a healthy monthly cash flow.

“We try to keep all of our rents around $800 a month, and we’re finding now that average rent on like a two- or three-bedroom place in Dayton, depending on location, is $950 to maybe $1,050 a month,” Stuber said. “As long as we can keep a good tenant, we’re happy.”