How do I decide where to buy my first rental property?

[Cassandra Boyett]

We own a house and want to purchase our first long term rental property. We live in California so real estate is pretty expensive here and we only have about 30k to start off with. I have no idea where to start looking?! 

Thanks!

Casey

[Eric Fernwood]

Hello @Cassandra Boyett ,

Based on how you asked your question I can tell that you have made the mental leap that you have to buy where you can make money. Too often people choose to buy in their own area just because it is physically close despite the return. So you know my bias, I am a Realtor in Las Vegas and my practice is almost exclusively remote investors (other states or countries). So I see no problem with remote investing if you have a team that you can trust.

There is no easy answer but I will tell you how I would look for the right properties. I think it is important to establish clear criteria so that you can quickly vet potential properties. Once you have a clear criteria (what I call a property profile) the search becomes easier because you know exactly what you are looking for. You may have additional characteristics but I would recommend three at a minimum.

1) The property must generate a sustained positive cash flow.
2) The property must be located in an area likely to appreciate.
3) Landlord friendly laws and taxes

Combined, these three requirements are not easy to fulfill. I will provide a little detail on each of the three criteria:

• Sustained positive cash flow - The rent is high enough compared to the purchase price so it generates a profit and the time to rent is low. There is a lot more I could say but for the sake of brevity I will stop here.
• Likely to appreciate - In order for a property to appreciate you need a stable or growing job market and stable or increasing population.
• Landlord friendly laws and taxes. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict a tenant and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500.

Next: where and what to buy and can you make a profit? The process is illustrated below:

The steps I would take are as follows:

• I would choose a city that has experienced sustained growth and is likely to continue to grow. Here is a map showing growth trends of major cities.
• I would limit the locations to major cities with airports so you can easily get there. Also, I would choose a place where you would like to visit because (check with your accountant) trips to check on your properties are probably tax deductible.
• State/city/county income taxes. Most states have a personal income tax. This can significantly impact your return. Nevada, Texas, Washington and Wyoming are among the states with no personal income taxes.
• A location where annual maintenance costs are reasonable. Higher costs are sometimes due to climate or construction issues. For example, in heavy snow country you will have to include snow removal costs and more physical damage to driveways and the structure. 

Once you have your top 5 cities, the next thing you need to know for each of your candidate cities is the type, configuration, location and rent range of the best rental properties. How can you find this out easily? Talk to local property managers. Property managers deal every day with tenants, maintenance issues, renting vacant units, local laws, evictions, etc. In short, every thing you need to know. Talk to 4 or 5 mid-sized local property managers in each city you are considering. Tell them that you are new to investing and are looking for a property manager to work with. Develop a list of questions and ask the same questions of each property manager. (I have a set of property manager interview questions, drop me an email if you or any one else would like a copy.) After only a couple of interviews you will begin to have a very good understanding of the local market and what type of properties rent best and how long they typically take to rent if the properties are market ready. Remember that the property managers only make money when they collect rent so they want rentable properties too. The specific information you need includes:

• Type: Condo, high rise, single family, duplex, single story, two story, etc.
• Configuration: Two bedroom, three car garage, mud room, etc.
• Location: Usually a very specific area. For example, west of 23rd St and south of the river, etc.
• Rent Range: If the majority of the population to which you want to rent are willing and able to pay $1,000/Mo to $1,300/Mo. you should only be looking at properties that you can purchase, rehab and profitably rent in the same rent range.
• Property laws, taxes and regulations: This is a catch-all category of local/state issues that affect landlords: eviction process and costs, rent controls, state/local income taxes, etc.

You should now have a very good idea of what properties rent best and how much they rent for. The next step is to determine what such properties cost. The property manager may be able to help you here but if not you can use Zillow. Find recently sold properties that match the type, configuration and location you learned from your property manager interviews. Once you know typical costs, it is time to determine whether you can make a profit.

In my practice I am almost constantly making what I call an investigate/forget decision. I do this so often that I created an online tool which enables me to instantly estimate a break-even price (where rent equals recurring expenses). Below is a screen shot of the tool.

In the example above I entered the estimated rent and the other factors and tapped Estimate. The result is that if the property were purchased for $185,000, the rent ($1,200/Mo.) would equal the recurring costs (debt service + taxes + insurance + property management fees + monthly fees). This means that if I thought I could get the property for $165,000 I would investigate further. If I thought I would have to pay $185,000 or more for the property I would forget this one and look for another. Remember that this tool is only for making a quick investigate/forget decision, not a purchase decision. If you (or anyone else) are interested in using this tool, drop me an email and I will send you the link. There is no charge or obligation for using the tool.

At this point you will know whether you can make an acceptable profit in a certain market. If yes it is time to dig deeper and start looking for a local Realtor that you can trust. If not move onto the next city.

Casey, I hope the above will get you started. Feel free to contact me if you have questions.

Best Wishes,

Eric Fernwood