House Hack or Invest OOS?

Question

Hi BP friends - I'm moving to San Diego for work and have been preparing and saving to start investing for quite some time. I have around $100k capital to invest, and I've prequalified for a loan up to $1.2m. Initially I was thinking of house hacking a multifamily in San Diego, but I'm starting to think it may be a better strategy to buy out of of state properties since obviously properties in San Diego are extremely higher cost and will likely be hard to find a deal that cash flows. If anyone has any advice or recommendations I would greatly appreciate it!

Thanks in advance,

Lee

Thanks in advance,

Lee

Twana Rasoul · Answer

@Lee Ratner - First rule of investing is to start in the market that has the best California Burritos.

I recently sold off all my midwest "cashflowing" properties to buy more here in San Diego.  There is a terrible misunderstanding regarding initial cashflow vs long term cashflow and initial cashflow and over ROI.  In the long run you are most likely to have the highest overall returns here in San Diego than you would in any initial cashflow market.

That $100k will make you a lot wealthier in the long run investing it locally than it will being used to purchase a 200-400k property in a random market.  Most of those who say investing in CA or San diego is a speculation or appreciation only play have more than likely never invested here.  It takes less money to house hack a $1M duplex here in San Diego with 3.5% FHA loan than buying an investment property out of state at $200k which usually requires 20-25% down.

I house hack here myself and even if you decide to go out of state for investing, you certainly should start with buying a duplex here.

Welcome to San Diego by the way :)

Dan H. · Answer

I recommend all newbies start local.  I believe the smart local RE investor can succeed in almost all markets.

Few OOS RE markets have more potential than house hacking than San Diego. Here are some of the reasons:

• There is a poor correlation between a markets initial cash flow and the cash flow achieved over a long term hold. This is because prices are set by a market that factors in numerous parameters. Two primary parameters factored into the price is expected appreciation and associated risk. The cheap markets that have good initial cash flow are that way because they typically that way because they are not expected to have much appreciation (both property and rent as there is typically a relationship between the two). It is simple math that the RE with the better rent appreciation will always eventually have better cash flow (assuming rent is increasing faster than expenses) than the slower appreciating RE. It is simple math.
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• The high owner occupied LTV (Likely up to 96.5%) allows your money to purchase much higher value when house hacking compared to OOS (likely up to 80%).  This better leverage of investment increases any rate of return.
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• Local investing is easier to build/maintain team, easier to self-manage, easier to do simple fixes to save money, easier to perform heroics if ever necessary, local knowledge, etc.  Self managing can save the PM costs (but it does take work) which is often necessary when first starting out.  Easier heroics if needed, we had 2 instances of our OOS units getting hit by hurricane.  Both eventually resulted in us having to go to the property to get the work done.  These trips occurred after not getting much progress on the work from OOS.  It would have been much easier to have handled this issue if we were local.  There are numerous minor repairs for every significant repair.  Items like towel bar coming off wall or cabinet trip coming loose.  These are easy to fix to save some money which again is critical when starting out.  We were over 10 units when we started hiring out our local handyman type tasks.
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• The historical appreciation: Case Shiller has San Diego as the number 3 highest return market in the US for this century. Neighborhood Scout shows San Diego a 10/10 for this century in appreciation.
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• Property 13: This is an under appreciated benefit for long term holds.  We currently have a property that is taxed at about 20% of what it would be taxed if purchased today.  We have another property that the ratio is not as good but the actual dollars difference is greater.  We are taxed at ~10K/year and the current rate would be ~$25K/year.  Note that is over a $1k/month savings resulting from prop 13.
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• I do not understand putting much more value on one type of return than another.  Granted it is a little harder to extract appreciation than cash flow but not much harder.  For me I seek best total return.  On my RE, my property appreciation has been far higher per month than very good cash flow markets.  What has this done to my rents.  All of my properties have rent above 1% rent to purchase ratio.  Some have over 2% ratio.  This ratio is achieved on top of the outstanding property appreciation.
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• The stats are out there.  You can find out that San Diego has experienced 164% appreciation (Source Neighborhoodscout) this century and ~24% appreciation in the last year.  You can find out what rents have done and what they are projected to do.  You can research prop 13 and its advantage to long term RE investors.

You live in an incredible RE market.  #3 according to reliable source (Case Shiller) for this century.

Good luck

Lee Ratner · Answer

Thank you everyone for your amazing insight - I'm definitely convinced to start by house hacking locally in San Diego :)

Darius Ogloza · Answer

@Lee Ratner  Like @Twana Rasoul I learned about "cash flowing" midwestern properties the hard way back in 2004-14.  In addition to the flaws in the cash flow logic Twana Rasoul points out above, you also run into the danger of overpaying for your "turnkey" (turkey?) out of state investment (even though it looks cheap) and in the end never even recover your initial investment.   I now invest only in high growth areas.  The "cost" of an investment is not really relevant to anything.  It is "value" you should focus on.  An investment's value is measured by the total expected return over time.  Don't end up buying Enron stock because on paper it has a (temporary) high dividend.

Lee Ratner · Answer

@Lucia Rushton Great point - my initial thought was trying reducing the $2000+ I would spend on a 1br renting which like you said is the point of house hacking. I suppose I'm just trying to determine which method in the long run will have the best chance for highest ROI (whether I buy OOS right now in a high cash flow scenario or start by house hacking)

Lucia Rushton · Answer

@Lee Ratner. I am a big proponent for house hacking. But just to be clear, they don’t usually cash flow when you live in them. The idea is your rent is partially or fully paid for by your tenants.

So when you look at cash flow you need to look at the future rental values not today’s.

Now if you decide to invest OOS, will you be renting ? Any paying someone else’s mortgage ? Just a thought

Rick Albert · Answer

Everyone has different views and it is one of those things were everyone is right.

I always tend to lean towards house hacking for a few reasons:

1. You know the area.  You know the streets and the neighborhoods.  This saves you time.

2. If you are willing to live there, then so are your future tenants.  This gives you an idea of who your future tenants are going to be.

3. You may be cash flowing on OOS rentals, but then that money goes towards you paying rent on your place.

4. Even with all of the hype around people leaving California, it is still poised to do well.  Especially in areas like San Diego where people are leaving LA and going to surrounding areas.  As mentioned before, there is opportunity for appreciation.

5. I've noticed in high cost areas it is not just an appreciation play, but also a long term thing.  Think about what happens with the mortgage is paid off.  Those are much bigger numbers with fewer units.  It might take double or triple the amount of units in another state to accomplish the same thing here.

I hope this helps.  Good luck!

David Frandsen · Answer

Either could be a good option. I've never done out of state but the folks I see that do it have built a solid team (agent, management company, ect.) The advantage to house hacking in San Diego is you can presumably offset your mortgage and end up with a small payment. Locking in your payment is advantageous with rising rents and you will also be paying down the principal on that property. The big play would be to purchase a multifamily property and build two additional ADU's. Then you are really crushing.

Gaetano Ciambriello · Answer

I could not agree more. I advise clients and friends to invest in the market they know, even if the price point is higher than going OOS. Local knowledge trumps having to invest OOS (especially with 1-4 family rentals). Also, I think investors should focus less on day 1 yield and look more at the fundamentals of the real estate they are buying.

Maxwell Ventura · Answer

@Lee Ratner

You've received a ton of great advice so far.

In a nutshell:

• I'd recommend staying local for your first deal.
• It's okay to diversify your RE portfolio, but consider taking advantage of each area's strengths. SD's is obviously appreciation.The beautiful thing about appreciation is the market is going to do regardless of your financing. Your CF will be dependent on your financing. By coming in w/ low money down in a high appreciating market the return on your investment will be very good even if the market even continues to appreciate between 5-10% a year here. Of course, this is only 1 portion of your turn. 
• Consider leveraging debt when you can (Coming in w/ little $$ down on an owner occupied residence).
• Get w/ an expert who is familiar with zoning. Aside from renovations and strategic fix ups, you'll be able to extract value from leveraging non-optimized opportunities on the lot. Some cities are better to work in than other for this, SD City being the best IMO.
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House Hack or Invest OOS?

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