How to invest in expensive markers?

Question

I'm wondering how people invest in markets like Raleigh, Austin, Jacksonville etc where median prices are 300-400k and able to cash flow. I invest in areas in NC where an average deal would be 130-150k and rent at 1300-1400, then when I cash out I'm left with a couple hundred dollars.

At the higher price points assuming you use leverage it ends up in negative cash flow, even before the crazy rate hikes we saw recently. So curious how do people invest in these areas at scale and if I'm potentially missing something.

Russell Brazil · Answer

Im sure I have substantially more cash flow from my DC and Boston properties than people who buy in high cash flow markets.

The high cash flow markets typically have very little to no rent growth, while the expensive markets typically have very high rent growth. So with just the passage of a little time, those properties with zero cash flow in DC, NYC, Boston end up having cash on cash returns that far exceed Baltimore, Detroit...it just takes patience.

Chris Seveney · Answer

@Roy Gottesdiener

It’s appreciation game not cash flow. I have a few rentals in DC area that we purchased back in 2013 and 2014 and had very little to zero cash flow. They now cash flow and have appreciated 6 figures - so when people say buy for cash flow I would argue that theory as over long term appreciation is the play.. I believe a mixed balance is required of both but long term wealth is by appreciation

Yes you will have declines in prices etc but historically price declines are temporary

Allan C. · Answer

@Roy Gottesdiener you’ll have a to differentiate between Year 1 cash flow vs future year cash flow. High cost markets often have low to negative cash flow for first few years, but rent appreciation exceeds cash flow of low entry-barrier markets after 5+ years.

It’s important to build cash flow models to properly compare NPV and IRR of markets with differing cash flow profiles. Investment proficiency factors the amount of cash and the timeline of cash returns - both are important.

Jon A. · Answer

@Roy Gottesdiener A couple things. First, it is possible to find cash-following assets in expensive markets. You just have to look hard and with a discerning eye, and be willing to buy properties in terrible condition/situations.Second, rents tend to rise faster in expensive markets. So, even if you're just breaking even in 2023, you will be cashflowing a few years down the road. But the name of the game isn't cashflow, which is taxable. It's equity, which can be accessed without paying taxes.

Account Closed · Answer

@Roy Gottesdiener - great question to ask. When considering an expensive market, it's helpful to focus on what makes that market so expensive. I think it's great when markets like Raleigh-Durham rise in value due to migration patterns and new development, but there are some other fundamental factors to consider as well. One of those factors is how limited new development is now and will likely be in the future. I'm sure @Russell Brazil can speak more authoritatively on this, but one of the compelling aspects about the DC market is that there is a strict physical limit as to what can be built within DC proper - there are strict height restrictions in the District which limits multifamily development and within the 68.3 square miles of land within its borders, there is very little viable open land for new development. This sort of factor enhances the scarcity of properties which is what leads to their heightened values, desirability and, over time, appreciation in rents.

Jon A. · Answer

No, I never accept negative cash flow post-stabilization. That's too much risk imo. I do usually leave a little money in the property when I refi post-stabilization. And unlike some folks i know who invest in low cost markets, I never cash out for more than my all-in costs.

Pat Lulewicz · Answer

@Roy Gottesdiener "ok" neighborhood is going to be subject and biased. I've lived anywhere from a duplex in E Raleigh to new builds in Morrisville and a couple of stops in between, so my personal opinion and experiences will be different from yours, and any other person's. In addition, our underwriting assumptions and lending scenarios will effect the ultimate "cash flow" number. With that being said

NE Raleigh is a great place with high demand. Garner and Clayton have nice cash flows. N Durham has plenty of inventory. I bring up these locations because I'd argue you can reach cash flow buying "retail" properties that are rent-ready from Day 1, but also provide opportunities for value-add which is where my equity positions have come from. I'm not buying every property that pops up; only need a few triples or home runs to make a good portfolio/career out of it.

Russell Brazil · Answer

There's no such thing as a negative cash flow property (assuming its rented for market rent).

This is an important fundamental to investing to understand. If you are negative cash flow, it has nothing to do with the property. You are negative cash flow because of your leverage, your debt service. Decrease your leverage and your cash flow increases. Increase your leverage and your cash flow decreases.

Roy Gottesdiener · Answer

@Chris Seveney @Russell Brazil @@Jon A. @Allan C. Thank you all for the input. Totally valid point about rent growth, but does that mean you're willing to take deals with negative cash flow on the beginning under the assumption that in a couple of years you'll be able to raise it?

Roy Gottesdiener · Answer

@Pat Lulewicz thanks. From the deals I'm seeing in Raleigh Durham in OK neighborhoods I'm always ending with negative cash flow because price to rent ratio is not great. Where are you finding deals with positive cash flow? Or are you sucking up losses until you can raise rents to the point you're making positive cash flow?

How to invest in expensive markers?

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