Newbie: First Property in SoCal (local area) or Out of State?

Question

Would love to hear opinions on purchasing in the more expensive Los Angeles / San Diego areas for first rental property to keep it closer? Or look at lower priced markets out of state?

Hesitant in out of state due to the obvious distance of the property -- but can make better use of funds with possibility of purchasing multiple properties vs only one in local area. Also keeping an eye out to 'house hack' with a duplex while living in one unit. Just beginning my search but realize that's harder to come by in the LA / OC area.

Appreciate all of your insight!

Account Closed · Answer

@Matt Banahan and @Yu Liu,

Please listen to Dan. Do yourself a favor and save the headache and heartache with OOS investing. Cheap doesn't mean good value while expensive doesn't mean bad value. Change your mindset and don't settle for the path of least resistance. Scratch OOS investing out of your head please. Everything in life has a price.

If your plan is to build wealth now and even multi-generational wealth, invest in appreciation markets along the coasts. Investing locally gives you a huge advantage. $100-$200k equity could be had with your local knowledge. At $200/mo/rental cash flow OOS, it would take 40-80 years to get that $100-$200k in equity.

The property may not cash flow well now, but given the history of rent growth in our markets, it will likely cash flow $1k-$2k/mo/door in 10-15 years. Along with that cash flow, equity gains will be in the hundreds of thousand of dollars per property.

Work and save to invest would take forever. Learn to scale up your REI biz and you're home free. $100-$200k equity gain/property = $1-$2M for 10 properties. In a decade or two, you're looking at a few millions in equity purely from appreciation IF history is any indication of course. What is more passive than appreciation?

Best of luck.

Dan H. · Answer

I do not remember what I have in my profile but we had two OOS RE both in Alabama.  A duplex on the beach and a SFR on a lake.  Neither were the cheap zero appreciation variety but both were much cheaper than CA.  The SFR there is not much story.  We bought it, had a few tenants the last of which stayed a long time and when they finally gave their notice we sold it because we were doing better in San Diego area.  We did OK, but we have done great in San Diego.

The more interesting was the duplex.  It was the type of RE that in So Cal would be a rare property.  It was on the beach sand (Gulf Shores, AL).  In So Cal the RE would be over $5M.  We purchased it and had it as an STR.  It was producing good cash flow and appreciating but our prop taxes were going up faster than the rent.  The area got hit by a hurricane.  Most properties were destroyed.  The properties destroyed had to be set back from the water further making our unit even nicer compared to the competition.  Our property survived but had a lot of damage.  We had insurance so our costs should have been limited to our deductible.  We (or our PM) could not get it worked as everyone needed contractors.  After quite a few months we went there to manage the rebuild more hands on (additional costs, we stayed a few weeks).  The insurance went up significantly.  Then it got hit by a second hurricane.  Same scenario.  More units destroyed and again our unit survived with significant damage.  We had to go there again to get the work done (additional costs).  Insurance went up even more (I think it was $8K/year when we sold more than a decade ago).  Between the two hurricanes, maybe 10% of the properties were still in their original location (including ours).  We were done but so were a lot of other owners.   All that prop tax paid at higher valuation was basically wasted as the prices fell significantly.   Again we did OK on our investment but we do better in San Diego.  Knowing that the area has not suffered a similar fate since then (20/20 hindsight), we would have been better off holding the RE.  The area is awesome.  The property was awesome.  But this property really taught me the benefit of prop 13 even more than having property here with tax basis of about 1/3 of current valuation.  It also taught me the difficulties of OOS RE.  Most importantly, it taught me that San Diego RE provides such a great ROI that there is no reason for us to go OOS.

So we had OOS but it is not the tradition OOS experience.  It was not in a zero appreciation market.  It had rents that could cover maintenance/cap expenses (due to two heavy rebuilds done on insurance dollar including full plumbing and electrical we had less cap ex than should be expected).  It really had some poor timing but our lessons still have some similarity of the traditional OOS markets such as difficulty getting good contractors (in our case due to contractor shortage due to disaster), sky rocketing property tax and/or insurance (in our case both), and the difficulty in dealing with any issue from a far.

We may once again try RE from a far.  If we do it will not be in the zero appreciation markets.  I have no interest in owning a unit for a couple/few hundred dollars of cash flow per unit (and this likely exceeds what most OOS investors will achieve) that will never become greater.  It will likely be commercial MF (5+ units).

Good luck

Account Closed · Answer

@Sean McCluskey, same effort could produce more equity in our expensive markets given we have the local knowledge advantage. However, the level of entry is also higher, but this hasn't kept the competitions away much.

There maybe short-term negative cash flow while you're stabilizing the asset, but the asset should give you positive cash flow in addition to a ton of equity once stabilized IF you figure it out. Approach real estate investing like a business and learn how to scale it. Without scalability, it’s hard to thrive with the savings of your W2 income. Here's an example: We're in contract for a duplex in our market (East Bay) for $400k. Rehab cost is estimated to be $125-$150k. Holding cost is $25k. ARV is $850k+. Gross rent is estimated to be $6k+/mo (Two 3/2 units). HML is 90% LTC + 100% rehab loan at 8.5% with 1 point.

I got lucky I started at the bottom of the crash 2009, or did I? I actually recognized an opportunity once in a lifetime and jumped in head first. I was stupid enough to quit my 6-figure W2 to pursue real estate full-time with $50k in the bank, a $250k HELOC, and $580k mortgage on our home. Within 3 months of me quitting, my wife got laid off. She was 7.5 months pregnant with our daughter. That was how I started. When your back is against the wall. You're forced to figure things out or sink. It's only apparent after the fact that quitting my job and my wife got laid off were a blessing in disguise. The lending environment was ultra tough during those years. Deals to be had, but no liquidity (so hard to get loans). My initial goal was 10 rentals in 10 years. Guess what, within 3.5 years, I managed to acquire 16 rentals with a couple partners (my share was 11 units). Then I said why not make it 30 rentals in 10 years? I blew past that too.

The point is regardless of when you start and your circumstances, there will always be challenges and obstacles. Only hindsight is 20/20. The formula is quite simple

1) Buy below market and/or forced appreciate the asset. This allows BRRRR and make the biz scalable. Why would an agent/broker give the deal to you instead of a list of his preferred clients? What do you have to do to get a shot at the deal?

2) Financing (control and leverage). Right now, interest only (IO) loans could be had on 1-4 units in the 3%...ish. Fully amortized loans could be had in the 3%...ish for commercial real estate. Learn the five C’s of lending and make banks want to lend to you.

People keep repeating this stupid mantra about negative cash flow in the Bay Area. If you know what you're doing, there's cash flow to be had on a regular basis. I can eyeball a deal from miles away and give it a yay or a nay.

@Matt, hope this post answers your questions too.

Best of luck.

Dan H. · Answer

If your planning on holding long term, coastal So Cal will far out produce the zero appreciation markets.  Not only will it produce far better return due to its property appreciation, but it will produce better cash flow.  This is really simple math, the area that has the greater rent appreciation will always eventually produce the better cash flow (assuming the rent appreciates more than expenses which is almost a certainty if financed with fixed rate loan and the near fixed property tax of CA due to prop 13).

The issue is in the short-term the coastal So Cal RE will have negative cash flow when coupled with a high LTV loan.  This implies the coastal So Cal investor must be committed to the long term return because the first couple of years will be the worse in terms of cash flow.

Good luck

Curtis Chism · Answer

Hey Matt, I think investing out of state can definitely work if you have the right team on the ground there. That can take a while to build out remotely. I just met with a friend who owned 25 units out of state but bought in areas he didn't have a great team/were higher risk/reward opportunities that just didn't work out for him. He's selling them all off now to either invest locally into a couple properties in the San Diego market. Whether investing out of state or in your own market, you'll still want to have a good team in place of course! Cheers!

Dan H. · Answer

>What has been your approach to this problem?  Did you have tons of capital to start with, maybe from a HELOC on a primary? Did you have very high annual incomes to plow into down payments, or did you BRRRR (or semi-BRRRR) houses, managing to get mortgages despite negative cash flow by using your W2 income in DTI ratio?

We started slowly knowing nothing except the belief in property appreciation.  Many of our properties (the early ones) were purchased without any pro forma. These were cheap RE in a decent area that was purchased at max LTV.  I knew the rent could cover the mortgage but did not have a clue as to vacancy rates, maintenance costs, or cap expenses.  However, I always knew the value of value adds.  There was no BP to easily get RE knowledge.

Our best RE homerun to date was primarily seeing the potential of STR in a great STR location before most others realized this potential.  That RE is up over $800K and rents for $16K/month average (purchased for $375K - all of our investment costs were extracted from this property quite a few years ago).  Most of our recent purchases have been traditional value adds (BRRRR) in a working class city.  We have done great with those, but without market appreciation we would not yet have been able to extract all of our investment costs (due to a combination of low LTV and conservative refi appraisals).  Even without being able to extract all the investment costs, if I have a non-owner occupied RE worth $600K and I have $20k or $30K of my investment trapped at the first refinance then that is still great.  With market appreciation, the majority of our properties have had all of the initial investment extracted.  Therefore, we have very little invested in our RE in comparison to their value.

So if you can do a pretty good BRRRR, the majority of the investment is only trapped until the refinance.  This local BRRRR is more likely to succeed than attempting an OOS BRRRR.  Remember to allocate for slightly low LTV (75% LTV), conservative appraisals, and the seasoning period.  I will be surprised if you can regularly obtain $40K of forced appreciation in the low appreciation Midwest markets.

BTW DTI has never been an issue on our loans for SFR to quad.  My DTI is horrendous, far worse than 100%.  I make pretty good money at my W2 job (my wife has not worked for ~5 years other than as PM for some of our RE), but we owe a fortune (we owe over $3M).  I do not believe DTI is relevant on SFR to quad; at a minimum it is not a disqualifier.

Good luck

Kiera Underwood · Answer

@Matt Banahan I see many SoCal investors going out of state. I've talked to a few who have a few "near home" that they hold on to but that ultimately want better returns and bang for their buck with any new purchases at this point in the market cycle. I'd consider SoCal more if we were in the middle of a downturn, but we're sitting at the top of the market cycle right now.

Matt Banahan · Answer

Account Closed Makes me realize I have / always will have a lot more research & knowledge to gain in the real estate world -- and to challenge the status quo of many preconceptions (ie. Bay Area is too expensive / negative cash flow). Very helpful, thanks for sharing background on your start as well, Minh.

Yu Liu · Answer

Account Closed Thank you for that perspective. I guess my question in investing in California then becomes, what is the worst case scenario and how do I prepare for that? Let's say I buy a house on a FHA loan (with market prices of $1M) and house hack it for example, how long would I have to hold it (with current market trends) for it to become remotely profitable. If I suddenly can't live in it after two years, how do I make sure it doesn't become a money pit? I guess that is the fear that we all have at the end of the day that stops us from taking action so I would like to hear more perspectives on that.

Matt Banahan · Answer

Account Closed mentioned -- I'm viewing OOS as a way to own multiple properties quicker (due to lower prices) vs. maybe only owning 1-2 in California as of now. May have a point that owning 1-2 in California may still be much more financially beneficial than 5+ OOS. [Being new, still working on understanding / applying numbers to determine # of doors I can purchase]

Just began reading David Greene's 'Long Distance Real Estate Investing' book to offer that alternative perspective.

Newbie: First Property in SoCal (local area) or Out of State?

Most Popular Reply