Hometown Bias: The Enemy of Successful Investment

[David Haynes]

I grew up in a small Alabama town where it was rumored, "Everyone born here stays here." The prophecy didn't prove true for me, though it did for many of my old friends. I just couldn't get used to chewing tobacco and cotton fields. I ended up moving to Europe, completing my M.S. in Finance, and starting my real estate career in Philadelphia. Now don't get me wrong. I love Alabama, but I'm definitely odd for not having that hometown bias.

People often do develop a "hometown bias". How does that affect our real estate investment? If I ask you where your first investment property was (or will be), odds are it was (or will be) in your hometown. This is completely understandable. You understand that area and think that you have strong negotiating power, networks, and insights. The problem comes when you start expanding your real estate portfolio and avoid venturing out of your hometown comfort zone. The lack of diversification brings a high level of unintended risk. 

Here is a strong example of how that risk is affecting investors today:

Let's say you have one rental property in Manhattan. For years the rent has been strong, your tenants have been pleased, and your cash flow is very rewarding. Then COVID hits. Most jobs and schools switch to online working and online studying. Consequently, your tenants no longer find living in the city a necessity. They can work from home anywhere and their children are being taught on their iPads. Why continue paying high rent for a small apartment in a populated city when you could be doing the same exact thing anywhere in the world? Your tenants move out to find an affordable, spacious SFH in the suburbs of Philadelphia. And they're paying the same price. Hoards of people are doing this very thing! Check out the news: Empty Manhattan apartments reach record levels, landlords slash rent. Your one property has now lost significant income and value. That's fine. It's only one property and you have a full-time job. You'll recover. Sadly, this can't be said for investors who concentrated their entire 50-property portfolio within Manhattan. Hometown bias is the enemy of successful investments. 

Here's how to break out of your hometown comfort zone:

Sophistication: By "sophistication" I mean experience and knowledge. A study conducted in October of last year showed that investors who broke out of their hometown bias had several investments under their belt and, consequently, had a thorough knowledge of real estate investing. Through experience, their investment strategies became more sophisticated and diversified. Sophistication comes through experience. However, sophistication can also come through studying. Many of us won't get the chance to speak personally with Brandon Turner, but we could speak with him right now if we open his books or listen to his numerous podcasts. Take advantage of that. I'm impressed by the diversification he has within his portfolio. 

Self-realization: Many hometown investors assume that their local knowledge is helping them make wiser purchases. The opposite is actually true. Research has shown that local investors are, more often than not, paying a premium for their local properties. This makes sense, right? If you go to a shoe store looking only for Lebron shoes, you are unknowingly willing to pay a premium over any other similar pair of shoes. Your bias is costly. It hurts realizing you don't have an advantage over non-locals, but you must come to this self-realization.

Stoicism: Sorry, trying to stick with the "S"s. By this, I mean to be a Stoic. Don't let emotions come into play. Remember that real estate investment is a numbers game. The winners are the ones who use sound judgment, not the ones who follow their feelings. Learn to look at a property as an income statement, not as an easy commute to pick up the rental payment. Research has also shown that hometown investors are more likely to purchase non-locally when their own market has underperformed and a neighboring market has overperformed. Sounds smart, but this is still following your emotions! The technical term is momentum chasing. You are forever chasing the momentum but are never strategically placed to catch the momentum when it initially starts. That's a great way to drain the bank account. You're behaving no differently than the dot-com bubble chasers in 1999. Stoics look at numbers, diversify their portfolio, and never follow their instinct. They are the Warren Buffets of the real estate world.

In conclusion, get a few investment properties under your belt, but eventually break through your hometown bias. Never limit yourself to one geographic location if you're planning to scale your real estate portfolio. Diversification is key. I work with investors here in Philly. I'm often shocked to see experienced investors concentrated within one or two neighborhoods within the city. I often hear the phrases, "I only want Germantown" or "I only buy SFH in Delaware County." I wonder how the "I only want Manhattan" investors are doing right now... I do see the other side as well. Several investors from far away cities are choosing to diversify here. Most are coming from New York City, but I'm seeing investors as far away as Connecticut, Maryland, Florida, California, Canada, and even the Middle East. These will be the ones who succeed in any kind of market.

Do you have anything to add to this? How have you brought diversification to your portfolio? Have you struggled with hometown bias? How did you break through your bias?