What would you do if you were me?

[Aaron J.]

I'm 33 years old. I'm a newbie to real estate investing. I've been listening to Biggerpockets podcasts and reading through the UBG to REI book and I just finished reading Rich Dad Poor Dad. I definitely have a strong desire to move out of the current area I am living in now (Bay Area). I have saved a $45k nest egg from working over the years. I own a condo with my brother that will eventually be sold in the next year or he will buy me out which will bring my cash in hand to about $100k. I want to begin my wealth building ASAP but I want to make the right first move because I feel like I don't have any room to make any mistakes given my age. I have chosen to focus on the buy and hold strategy as I tend to think that it is a secure low risk way to build wealth over time and something I think I would be comfortable with. I am having trouble deciding on what city to move to where I can be happy there, and successfully build the real estate business on the side until I am able to quit the day job. I would like to not hire a property management company in the beginning so as to maximize cash flow, if any, or break even at least in the beginning and live frugally. My idea so far is to buy a duplex, triplex or quadplex and live in one of the units and then of course rent the remaining units out. I have considered Portland, Oregon but am very worried about the excessive rain. I have considered other areas in California, like Central Valley, but am very worried about the excessive heat. I tend not to do well with extreme climates...but I also am willing to make sacrifices to better the chances of success in my dream to have a successful real estate business, if all goes well, I can live anywhere right? So my question to you guys is, what would you do if you were in my cash position? What area of the country would you go to? What is the smartest financially intelligent move to make?

[Eric Fernwood]

You asked a question covering a lot of territory. I broke your question into the following items and will address each one as best as I can.

1. Should you manage your own properties?
2. How can you determine a good place to invest in real estate?
3. How can you make the best use of the funds you have?

Question #1: Managing your own properties
Managing your own properties is based on the assumption that you can save money or that there is some advantage. Most new investors believe that the only value of a property manager is to collect the rent. I wish it was that simple. When I first started, I managed my own properties. What a mistake! Each month I had to knock on the tenant’s doors since I did not receive the rent in the mail by the 1st. And, even though their cars were in the driveway and I could hear the TV, no one would answer. After losing a few months rent this way (I owned 8 properties at the time) I placed them in the hands of a bad property manager (I was no better at selecting property managers at that time than I was at screening tenants). She did collect the rent but then never deposited it into my account! Finally, I got the properties into the hands of a good property manager. To make a long story short, 4 of the 8 tenants had to be evicted and good tenants installed. My “management” time went from “most weekends and frequent evenings” to about 30 minutes a month. In total, I believe my attempting to save the 10% property manager fee cost me close to $10,000. Today I am a Realtor in Las Vegas and almost all of my clients are out of state/country investors. I have clients with enough properties that I could easily make a business managing them. Am I considering managing the properties? No. In order to be successful at managing properties you need a lot of property manager experience and hundreds of properties to justify the staff, software and processes. Just don’t do it. (if you would like to see what value a good property manager can provide, see this blog article). Finding a good property manager is not always easy. I have a set of property manager interview questions which I have developed over a number of years. If you would like a copy, send me an email.

I hope by this point you have decided not to manage your own properties. If this is true, the next issue is do you need to live in the same city? Based on my clients, I am convinced the answer is no. So, my advice is to choose a city for investment and choose a place to live. I do recommend that all things being equal, buy properties in a city I would enjoy visiting. When my clients come to Las Vegas to “inspect” their properties, a portion of the entire trip is a tax deductible business expense.

Question #2: Where and what to buy?

There is no easy answer to this question but below is the process I would use. Note that fully answering your question would fill a book so understand that the following is only an overview.

• I would start by understanding overall population movement trends. See population changes by state here. In general, I think the population is moving towards the southwestern states. This should narrow your search to only a few states.
• Each state as a limited number of viable cities since you need only look at cities that are sufficiently large so that there is a stable (and growing) population. I am guessing a population over 1 million people would be a good start. This should get you to 5 to 10 cities.
• A rental property is no more valuable than the jobs around it so you need to look at job stability in each of the cities. Googling each city and the local chamber of commerce web site is usually a good source. This should eliminate one or two more cities.
• For each of the remaining cities check the landlord/eviction/rental laws. For example, in Las Vegas a typical eviction takes less than 30 days and costs less than $500. I have heard from more than one of my clients that evictions in California (and some other states) can take up to a year if the tenant actively resists and cost thousands. (No investor initially worries about evictions, until it happens to you.) The best source for this kind of information would be talking to a few property managers in each city you are considering. I would choose mid sized property managers. They will have enough properties under management to know the market but small enough to be very interested in a new client (you).
• Property managers deal with the issues that concern you every day. They know what rents and what doesn’t. Pose the same questions to multiple property managers and you will quickly learn the real situation. Also ask about their fees and services. The basic issues I would investigate include:
• What type, configuration, location and rent range do they recommend? Remember that the property manager only makes money if there is a tenant paying the rent so they have the same goal as you do.
• Ask about the eviction process (time and cost), tenant rights laws, rent control and any other issues that will impact your profitability.
• Who are the major employers for these tenants?
• The last question should always be, “What have I not asked you about that I should know?” Over the years I have been amazed at the responses I have received to this question.
• Once you know the type, configuration, location and rent range of recommended properties, your next step is to determine whether you can afford to buy such a property and whether a typical property generates a positive cash flow. For example, if a typical rental property costs $400,000 and your budget is $150,000, don’t waste your time. Next, spent some time on one of the popular real estate sites and obtain information about possible rental properties in the remaining. What you are looking for are properties that were recently sold and the rental rate for similar properties. I selected three cities to use as an example: Austin, TX; Cupertino, CA and Las Vegas, NV. Then, using a tool I developed (Break-Even Calculator - see here for more information) I created the following table. The Break-Even Calculator enables you to determine the purchase price where the recurring costs equals the income.

• If the Break-Even Price is lower than the Actual Sold Price it is unlikely that properties in that city will generate a positive cash flow. As you can see, from the above, the prices of properties in Cupertino (and probably Austin) are too high relative to the rent to generate a positive cash flow. You should be able to generate similar data for all the cities you are considering in an evening.
• At this point you are probably down to two or three cities. Now is the time to call back the property manager(s) you liked the best for each remaining city and ask them to recommend a Realtor. Have each of the Realtors send properties which match the profile (type, configuration, location and rent range) you learned from your property manager interviews. Once you have the properties I would re-validate profitability using the Break-Even Calculator.
• Next, I would select one realtor from each city and go visit. There is no substitute for personally meeting the people who will be the core of your investment team. Note: tell both the Realtor and the property managers up front that you are in the investigation phase and are not “buying” anything on this trip. If any are “too busy” to spend time with you, then you know to eliminate them from further consideration.
• At this point I believe you will likely have enough information to make an informed decision on where and what to buy.

Question #3: How to make the best use of the funds you have?

A difficult question to answer without more knowledge of your situation. However, if you can obtain cost effective financing for investment real estate that is the way to go. One of the big advantages of investment real estate is the ability to finance a property over 30 years. Most of my clients put 20% down and finance the balance over 30 years.

Aaron, I hope the above will provide some ideas for further investigation. If you have questions, feel free to ask.