New investor interested in out of state RE. Any advice?

[Issac Chang]

Hey guys! I've recently got into real estate investing and would like to get some more advice. I'm 25 years old and currently living in North Jersey. My main interest is in brrrr strategy and creating cash flow. The problem is that the market here is too expensive and it's almost impossible to make positive cash flow on rental properties. Thus I've looked into several properties in other states and they seem more affordable. Is it too risky to get into out-of-state RE as a new investor? If anyone can help me with advice, I would really appreciate it.

[Eric Fernwood]

Hello @Issac Chang,

I believe that if the property does not generate a positive cash flow from day one, do not buy it. If you do, you just paid a lot of money to lose money in the hope that in the future you might make money.

“Live where you like but invest where you can make money.” …David Lindahl

The next question is where to invest. I believe every location/property must meet the following criteria.

• Sustained profitability - The property must generate a positive cash flow today and into the foreseeable future.
• Likely to appreciate - Unless the price and rent increase at or above the rate of inflation, your present value return and income are actually declining.
• Located in an area where you can make money and business risks are low.

Below is a diagram showing the process I would follow:

There are a lot of topics covered in the above diagram that it’s impossible to discuss them all here. So I will narrow my comments to the location, the Investment Team, and buying turnkey.

Location

With an almost infinite number of places you could invest, I recommend narrowing your location search based on the following criteria.

• Population > 1M - Smaller cities may be too dependent on a single industry or employer. Here is a list from Wikipedia.
• Crime - High levels of crime and long term profitability do not go together. NeighborhoodScout publishes a list of the 100 most dangerous cities in the US. I recommend excluding any city on this list because they are unlikely to get new jobs or grow in population.
• Appreciation - Unless properties consistently appreciate at or above the rate of inflation, your actual income is declining over time. Google for the areas you are considering. NeighborhoodScout generally has good information.
• Rising per capita income - If per capita incomes are rising, job quality and quantity are increasing. The St Louis Federal Reserve is a good source of such information. For example, here is the per capita income for Las Vegas.
• Increasing population - If the population is increasing, it is very likely that the location is doing well overall. The Census Bureau has good data.
• Finally, choose a place that you would like to visit. You may need to go there at some point and it would be nice if it is a desirable location.

Investment Team

With the right investment team in place it does not matter where you invest. However, it is important that you have the right expectations as to what the team members can provide. Below is a table showing what expertise you want team members to have.

The most important team member is the property manager.

Turnkey Investing

Buying from a turnkey provider is only a purchase method. It in no way diminishes the steps before making a purchase method decision. See the image below.

Potential issues buying turnkey:

• Possibly higher risk - Buying turnkey may preclude you from obtaining vital information on the property. For example, an independent inspection.
• Tenant pool risk - The property defines the tenant pool. The tenant pool the property defines may not match your investment goals.
• Locked in - Turnkey providers have a lot of expenses and all must be covered. One source of income is managing the property. You may have no option but to use their property manager and their maintenance staff for all repairs. What if they do not perform or are too expensive?
• If you decide to sell the property, you may be required to sell through the turnkey’s Realtor at whatever commission rate is in the contract you signed. This alone could cost you 2% to 4% of the sale price of the property.
• Lower returns - The return generated by a turnkey property will always be less than buying direct. The turnkey provider bundles all their costs and necessary profit into the purchase price. The higher the purchase price, the lower the return. (Return = Net Income / Acquisition Cost). See the diagram below.

Advantages of buying turnkey:

• Cost consolidation - “Batteries included” - You pay one price for everything including the property, rehab and tenant acquisition. Note, this assumes that the property appraises for the turnkey price. If it does not, you will have to contribute the balance in cash and this advantage goes away.
• Easy - This is the major advantage of buying turnkey. No decisions, no worries. Just secure the loan and close, and start receiving an income stream. In the short run, this is probably true. In the long run, probably not unless it is in a location that is appreciating at or above the rate of inflation.

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