Advise for starting an out of state buy and hold investing portfolio

[Max Balesteri]

Hello everyone,

I recently found and signed up for this great site. So far I've been reading a lot of posts and figured it's time for me to get involved a little more.

I recently started my research for putting together a rental portfolio and since I live in the SF Bay Area, doing this locally isn't going to work too well for a person with my starting capital. So I will be doing what many here say is very risky (which I can certainly understand) buying out of state. 

To minimize the risk, my first step is to find a stable market with EXCELLENT property management in place. Recommendations on buy and hold markets for SFR or MFR's and property managers are appreciated. So far I'm liking Charlotte NC, Raleigh NC, Indianapolis IN, K.C. MO, Marietta GA, Nashville TN, Memphis TN and the surrounding areas of these. I'm open to other areas too, so please feel free to throw anything out there. Just please offer some real info for why you're suggesting the area.

I'll be traveling to the 2 or 3 that end up topping my list and I figure I'll only have 7 to 10 days for this trip. So I really need to get the most out of the time I'll have to see the areas in person in order to make the best decision and make A LOT of offers. Now the offers part is if I don't choose the route of a turn-key provider, which opens up a whole different debate that's been covered extensively in MANY past posts. So if you're going to go into anything regarding these companies in this thread, please keep it to your particular experiences and share the turn-key company you used. I believe there are some good ones out there that will provide a good service for fair compensation. It's just finding these ones is tough since there are a lot out there with questionable values.

A little about what I'm looking for... My top priority for starting out is cash flow to reinvest in more properties. I'm thinking 3/2's or larger with around 1.2% rent to purchase, depending on other numbers for the location of course. This is because I'm looking for the more conservative entry into this and also because I'll be financing a good portion without funds for extensive renovations. I don't care to get into this to be a slumlord by any means. I believe that there are a lot of good tenants out there that can't or don't want to buy for various reasons and this is my target renter. I think you would call it C+++ or better.

I'd also like to ask for any websites or other ways to get concrete data for researching markets. I look mostly at government data such as census information and some I get from things like Forbe's magazine. But I've also seen a lot of data on Sperling's Best Places, I just haven't found anything telling me if it's accurate.

On a final note, as I am very new to this particular area RE investing. Please let me know your opinion of what I've stated above. I fully welcome others thoughts as I create my plan and realize that there are a lot of very knowledgeable and experienced people here, that I look forward to learning from.

Thanks to everyone in advance for your thoughts, stories, and information.

Sincerely,

Max Balesteri

[Eric Fernwood]

Hello @Max Balesteri,

You are way ahead of many investors in your thought process. Especially on these points:

• Cash flow is what matters
• Excellent property management is critical
• Buy where you can get good properties
• MF or SFR, it does not matter as long as they cash flow

Keep in mind that cash flow (or ROI) is really only a snapshot of market conditions today but real estate is a long term investment, at least 7 to 10 years. You need to look at longer term area trends as well as taxes and rental related legislation. I will talk about these topics later.

The criteria I recommend that you use to evaluate each potential property are:

• It is located in an area likely to appreciate over time
• It is highly likely to have sustained profitability
• Located in an area with real estate investor friendly taxes and legislation

The process I recommend is illustrated below:

Favorable Population, Employment and Crime Trends

The old adage that the three most important things in real estate are location, location, location is still true but areas change over time. Areas that are good today can decline and sometimes areas that were once bad get better. Is it possible to accurately predict what an area will be like in 15 or 20 years? No, but you can make a reasonable guess as to what an area will be like in 5 years and extrapolate from there. Three indicators I think you should evaluate are population migration, job stability and quality, and crime.

Population Migration

If people are moving out of the area, the housing prices and rental rates are likely to fall. If people are moving into an area, then there is likely to be appreciation and rising rents. Here is a website that shows population shift by area. Also, many areas have populations that are getting older. As people age they tend to want smaller properties and lower rents. If you are considering a property targeted towards families and the area is aging, you will likely find demand decreasing. So, also check the population demographics.

Job Quantity and Quality

In many parts of the US, manufacturing and similar jobs are going away and what remains are service sector jobs. Service sector jobs tend to pay less than manufacturing jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the level of rent they did in the past. Look at the major employers, what industries they are in and their future prospects. A key indicator is inflation adjusted per capita income over the past few years. If you see a declining per capita income adjusted for inflation, you need to carefully consider the long term value of the property. You have to be careful on inflation adjusted numbers. There is reality and "official" numbers. Official inflation during 2014 is 1.7%. However, “official” inflation numbers do not include energy or food. Personally, I use energy and eat so the inflation I experience is much higher than the “official” number. Depending on whose numbers you use, actual inflation is between 6% and 10% per year. Keep in mind that unless the per capita adjusted income is rising at or greater than the rate of actual inflation your potential tenants disposable income is eroding. What this means is that if you buy a property that rents at the upper end of the rent range, you will likely have increasing time-to-rent and declining rental rates over time. 

Crime

Stable or increasing property values and rents rarely occur in areas with high crime. When crime increases, people with sufficient income move to areas with lower crime. The people who cannot afford to move tend to have lower incomes thus resulting in falling rents and property values. What you need to consider is the types and frequency of crimes in the area and how it is changing. Where can you find such data? Here are some sites: crimemapping.com, homefacts.com, crimereports.com and spotcrime.com. Depending on your city/area you may have such data available from the local police department or the sheriff's department. Remember that it is not just crime in the specific neighborhood that matters, you also have to consider areas near the property where people will shop and such. For example, I was evaluating a property in an area that I did not know well so I used Google Street View to check the drive path to the property. I noticed a strip mall near the property where I anticipated tenants would shop. When I checked that location on one of the crime sites I discovered that robberies and assaults occur frequently at the strip mall and that the situation appears to have been the same for the past few years. I rejected the property based on these findings. So, check the shopping areas that tenants would use. You should also check the sex offender database. See familywatchdog.us but there are likely many others. Some states/counties/cities have their own sex offender/crime websites. 

Favorable State Income Tax, Property Tax and Legislation

State Income Taxes and Property Taxes

State taxes and property taxes are another big factor to consider since their impact on your real return can be huge. For example, suppose you are considering three identical properties that rent for the same amount (yes, this is an over simplified and contrived example!). And, one is located in Austin, one is located in Indianapolis, and one is located in Las Vegas. Which one is better? Below is a table showing approximate state personal income tax (I will assume a person filing separately with a $50,000 income) and property tax rates for all the cities. (Note, please forgive me if I am off on the values. My goal is to communicate a concept, not accurate math.) Note: Property taxes source and state income tax source.

Below is a (oversimplified) formula for estimating cashflow assuming 100% occupancy, no maintenance, etc. in order to keep the numbers simple. The property details are:

• Purchase price $150,000
• Rent: $1,000/Mo.
• Financing: 20% down, 4.5% interest, 30 year term.
• Down Amount: $30,000
• Debt Service (PI): $600/Mo

Cash Flow = Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice

And, to take into account state taxes:

Net Cash Flow = (Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice) x (1 - StateTaxRate)

For Austin: ($1,000 x 12 - $600 x 12 - 1.9% x $150,000)x (1 - 0%) = $1,950/Yr

For Indianapolis: ($1,000 x 12 - $600 x 12 - 1.07% x $150,000)x (1 - 3.4%) = $3,086/Yr

For Las Vegas: ($1,000 x 12 - $600 x 12 - 0.86% x $150,000)x (1 - 0%) = $3,510/Yr

In summary:

Real return is about how much money actually flows to you, not gross rent or ROI. Property taxes and state taxes have a big effect on the real return.

Legislation 

Legislation concerning tenants and rent vary by state, county or city and can have a huge impact on your return. One example is evictions. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. 

Location, Type, Configuration and Rent Range

Where can you get highly detailed information on the best rental property type, location, configuration and rent range in any area? Local property managers. Most new investors think of property managers as someone to collect the rent after they buy a property. I strongly disagree with this view. I consistently find properties for my clients that meet the dual goals of profitability and appreciation through processes and an investment team. The key member of any real estate investment team is the property manager. (I am a Realtor; I do not manage properties.) Below is a diagram showing four categories where a good property manager can help you be successful. Your initial interviews with three or four property managers will concern their local knowledge of: type, location, configuration and rent range.

Below is more detail on this four characteristics.

• 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.

Start by telling each property manager that you are just starting out and are looking for a property manager to work with. You need to have a well defined list of questions before you start interviewing and ask the same questions of three or four property managers. (I have a set of property manager interview questions that I'd be happy to share.) After these interviews you will have a pretty good idea of the local market and you may even have an opinion whether any of the property managers you talked to are people you would like to deal with in the future. Once you have a reasonable idea of type, location, configuration and rent range (which I call a property profile), you are in a position to determine whether you can achieve the other goal: profitability. 

Once you know the property profile you can use Zillow (or many other sites) to determine the typical sale price of properties in that local. With a reasonable knowledge of the rent and price of typical properties, you need 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. (I'm also happy to share it. There is no charge or obligation for using the tool.)

In the example above I entered the estimated rent and 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 cannot make a profit, look somewhere else. Once you find a place that looks to have good potential, get the name of a local Realtor from the property manager(s). Tell the Realtor what you are looking for (type, location, configuration) and have her/him send matching properties. This is important: many people think that Realtors know how to choose investment properties; very few do so you have to provide the criteria.

If you see a few properties you like send them to the two (or three) best property managers and get their opinion as to the property in general (will it make a good rental) and what is their estimate on the rent and time to rent. The answers from the property managers should be close. If everything looks good, I would travel to that location and meet with the property manager and the Realtor. These are the people who will be responsible for one of the more expensive assets you will own and you need to evaluate them and see some properties. 

Max, let the numbers be your guide; do not start with a pre-conceived technique, property type or location.

I wish you the best.