Invest in real estate locally vs remotely

[Carmen Ngai]

Hi there,

I am a newbie here. I have been investing in the stock market for years. Now I'd like to diversify my investment by getting into real estate, starting small, likely a 1-2 bedroom condo or townhouse and rent it out. I'd like to get some insights from the seasoned investors about your experience investing locally vs remotely. What are some of your biggest challenges?

If it is a city which you think it has growth potential, such as North Virginia Arlington area since Amazon is going there and their shortage in homes, would you feel it is justifiable to jump through extra hoops to buy remotely?    

Thank you. 

Carmen

 

[Eric Fernwood]

Hello @Carmen Ngai,

An excellent question. Whether you should invest locally or in another location is not an emotional decision, it is a spreadsheet decision. Let’s start at the end and work backwards to the location. I believe that every investment property must meet the following three criteria.

• Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future.
• Currently and likely to continue appreciating for the foreseeable future at or above the rate of inflation - Properties appreciate in locations that have strong demand, which is the key driver for sustained profitability.
• In a location where you can make money and you control your property as opposed to the government dictating what you can do.

Achieving the three criteria requires a combination of the right location, tenant pool, investment team and property. If you do not get one or more of the above correct, you are likely to lose money, at least for the short term. Of the four essential elements, the two most important are the location and the tenant pool. If you can meet all four in your neighborhood, there is no need to look elsewhere. If you cannot, then you have no choice but to invest elsewhere.

“Live where you like but invest where you can make money.” …Source unknown

Rather than suggesting specific locations, I listed below a summary of the criteria I would follow when selecting a location.

• Appreciation - Appreciation is the best indicator of demand. If properties are not appreciating, then there is limited demand. Rents lag property prices by 2 to 10 years so the trends in property prices today are a good barometer of what rents will do in the future. Also, if property prices are not rising at or above the rate of inflation, rents are effectively declining.
• Population size - I would focus on cities with a population of 1M or more. Small cities tend to be reliant upon a single industry, which makes them vulnerable to economic changes.
• Jobs - Unless your tenants are working they cannot pay the rent. Rental properties are no better than the jobs around it. Also, remember that companies do not live forever, the average life expectancy of an S&P 500 company is under 15 years. So, unless new employers are creating jobs of the same type and quality as your target tenant pool already has, look somewhere else.
• Population growth - If people are moving to a location, it is a good location for jobs and a desirable place to live. If people are moving away, demand will drop and prices will be static or declining.
• Urban sprawl - Not talked about much but you have only to look at any major city and you will see locations that were once the best in town and are now distressed. This is usually the result of urban sprawl. You need to be very aware of which way the city is expanding and buy in the direction where the population is moving. See this site for time lapses. Try: Memphis, Atlanta, Austin and Las Vegas. Las Vegas is surrounded by federal land so there is little room remaining for expansion or urban sprawl.
• Crime - High crime areas and long term profitability do not go together. I would not consider any city on the top 100 most dangerous cities list. You might know one of these cities well and know that there is a great area near the city. The problem is that companies looking to open new locations will not choose high crime cities. Also, people with sufficient funds will leave these areas and the area will go into further decline.
• Climate - Properties in areas with hard freezes and excessive moisture will tend to require more maintenance than in milder and dryer climates. Also, the materials generally used to build homes in cold clients requires more maintenance that materials used in hot dry climates.
• Age of the property - The older the property, the more maintenance it will require, unless all the major systems and components have been updated recently.
• Property cost - There is a tendency for new investors to choose locations with very inexpensive properties. Remember that price is a function of demand. No demand, low price. High demand, high price. Of course, you need to hit a balance. If your budget allows a maximum of $250,000, do not consider coastal California.
• Taxes - Both income tax and property taxes are a direct hit on profitability. High taxes are also a strong indicator of both an inefficient government plus a government usurping the rights of its citizens. We see across the US that people are leaving high tax states for states with lower taxes and regulations.
• Insurance cost - Insurance cost is a good barometer of the likelihood of damage, usually due to climatic or seismic events. Be certain to take the cost of landlord insurance into account when comparing locations.

Lastly, there is no perfect investment location. Factors such as not having a good investment team or properties that require a lot of rehab could make an otherwise good location unacceptable. So look for a good location and not a “perfect” location, they do not exist.