Investing in Ohio - Huge Mistake??

[Marian Henares]

Hello BP community!

I attended a real estate networking event this evening in my hometown of San Diego, CA, and during a segment where we each stood up and introduced ourselves to the group, I mentioned that I was interested in doing the BRRRR strategy and purchasing my first rental property in Ohio by the end of 2019 - someone in the crowd shouted out "Mistake!" I spoke with this person later in the evening and she informed me that Ohio would be a terrible place to invest. Any thoughts? Am I making a huge mistake by looking to invest in Ohio?

Thank you in advance for your insights.

[Dan H.]

I think it is probably a mistake.

I assume you are choosing Ohio for its low price.  This low price is due to historically poor appreciation.  Leveraged appreciation has an amazing effect on return.  

The first BRRRR process is challenging if done locally; real challenging if done OOS. I have done a few BRRRR and have yet to achieve the textbook BRRRR. Mostly I find the refinance LTV combined with the low refinance appraisals prevent me from extracting all of my investment.

So if you choose to go OOS here is some advice:

• Familiarize your self with the 50% rule. Any low appreciation market that has pro-forma that does not reflect the 50% rule is bogus. TK providers and RE agents will present various return projections that over estimate the long term cash flow. Make sure the cash flow estimates reflects the 50% rule (probably 60% allocated to expenses other than debt service would be safer for the pro-forma in the low rent units).
• For the low rent OOS markets, 50% rule is not a large enough percent.  This is because maintenance/cap expense has more to do with the RE abundant especially the structure than it has to do with the rent price.  A water heater costs the same for the $4500/month 2 br San francisco unit as it does for the $500/month 2 BR  Cleveland unit. 
• Get a 3rd party inspection and appraiser. No discount is worth the added risk of not having the 3rd party review.
• Realize that if you purchase a TK, it will start to depreciate immediately after put in use. The rehab will start to age. This implies a year or two in, it is inevitable that your equity has been reduced.
• Avoid the highest projected cash flow pockets in any area. These are typically the class D areas. I use the word projected because these areas only achieve the projected cash flow by expert LL in that class of property. Most newbies will have worse actual cash flow from these RE than the lower projected cash flow class B areas. Basically class D is more difficult to hit the return projections than class B.
• Even modest appreciation areas, when leveraged, can provide a good return from appreciation. The historically zero appreciation areas will not benefit as much from the leverage. Example: 75% LTV appreciates 2.5% in the first year and you have a 10% return on your investment and a return that is positive in inflation adjusted dollars. Basically this means avoid all of the cheapest markets. If you can purchase a SFR for less than $100k then this is a low appreciation market.  
• Low rent units set a low cash flow limit.  How much cash flow can you hope to get from a OOS $600/month unit.  One of my above bullets indicate expenses other than mortgage will be greater than 50%.   Then take out the mortgage. Probably lucky to get $100/month true long term cash flow.  
• The cash flow on appreciating market units will eventually always surpass the zero appreciation markets.  It really is simply math.  

The lure of the low cost purchase and initial cash flow (mostly exaggerated) make markets like Ohio tempting for investors from high cost areas.   Ironically it is this low purchase cost that is why OOS investors should avoid these markets.   Good luck