All Forum Posts by: Eric Fernwood

Hello @Masud Khan,

How much total capital you will need to acquire multiple properties depends on the appreciation rate in the city where you invest. If you buy in a city with a low appreciation rate, every investment dollar must come from your savings. I will use the following example to demonstrate the problem.

Suppose you invest in a city with low appreciation. I will assume you need 20 properties to replace your current income. Each property costs $200,000, and the down payment is 25%. I will ignore all other costs other than the down payment.

The total capital from savings required for down payments will be 20 x $200,000 x 25% = $1,000,000. Also, the $1,000,000 is post-tax dollars. If your marginal tax rate is 40%, you will have to earn approximately 1,666,667 to have $1,000,000 after-tax dollars to have the money for down payments on 20 properties.

Alternatively, what will be the total capital required to acquire 20 properties in a high-appreciation city? For this example, I will assume each property costs $400,000, you need 20 properties, and you will put 25% down. The down payment for the first property is $400,000 x 25% = $100,000.

Because you purchased in a location with rapid appreciation, the market value rises rapidly. Suppose the appreciation rate is 8% (FYI: The YTD appreciation rate for the property segment we target in Las Vegas is >9%). How long before a 75% cash-out refinance will yield the $100,000 needed for the down payment on your next property? For simplicity, I will assume there was no principal paydown on the mortgage; the mortgage payoff remains $300,000.

• Year 2: $400,000 x (1 + 8%)^2 x 75% - $300,000 ≈ $49,920
• Year 3: $400,000 x (1 + 8%)^3 x 75% - $300,000 ≈ $77,914
• Year 4: $400,000 x (1 + 8%)^4 x 75% - $300,000 ≈ $108,147

So, after four years, a 75% cash-out refinance yields the $100,000 you need for the down payment for the next property. Also, loans are not taxable, so you can use the full amount.

This is the method I and my clients have used to grow our portfolios. Also, as you accumulate properties, the rate at which you can buy additional properties increases. See the diagram below. In the diagram, property #1 is refinanced to buy property #2. Next, properties #1 and #2 are refinanced to buy properties #3 and #4, etc.

So, if you purchase in a location with high appreciation, you can use cash-out refinance to make down payments for additional properties. Theoretically, ignoring all costs other than down payments, you only need $100,000 to buy 20 properties. Despite the higher property prices in high-appreciation locations, this is the least expensive way to acquire multiple properties.

If the Appreciation Rate Is Low, the Rent Growth Rate Is Low

If your goal is financial freedom, buying properties in a city with a slow appreciation rate poses another problem.

Financial freedom is more than just replacing your existing income. It's about maintaining your current lifestyle for as long as you live. To achieve this, rent growth must outpace inflation. An example will show why this is true.

Suppose you buy a property and the monthly rent is $1,000, the rent growth rate is 2%, and inflation is 4%. What will be the rent's present value (purchasing power) at 1, 5, 10, and 15 years?

First, I will calculate rents at 2% rent growth.

• Year 1: $1,000
• Year 5: $1,000 x (1 + 2%)^5 ≈ $1,104
• Year 10: $1,000 x (1 + 2%)^10 ≈ $1,219
• Year 15: $1,000 x (1 + 2%)^15 ≈ $1,346

Next, I will calculate the future rent's inflation-adjusted value (buying power), including 4% inflation.

• Year 1: $1,000
• Year 5: $1,000 x (1 + 2%)^5 / (1 + 4%)^5 ≈ $907
• Year 10: $1,000 x (1 + 2%)^10 / (1 + 4%)^10 ≈ $824
• Year 15: $1,000 x (1 + 2%)^15 / (1 + 4%)^15 ≈ $747

So, in the 10th year, the rent is expected to be $1,219, but inflation reduced its purchasing power to what you can buy today for $824. This is the long-term financial trap of buying properties in locations where rents do not outpace inflation.

No matter how many properties you own in locations where rent growth is less than inflation, you cannot achieve financial freedom because your inflation-adjusted (buying power) rent is continuously declining.

Conclusion

If your property is in a city with a low appreciation rate, consider using a 1031 exchange to purchase a replacement property in a city with a high appreciation rate where you can use cash-out refinance to buy more properties and where your rents will outpace inflation.

Hello Paul,

We've completed more than eighty-1031 exchanges. There are three exchange agents I recommend. DM me if you would like their contact details.

...Eric

Hello @Benjamin Sulka,

We’ve operated a one-stop investor services business in Las Vegas for over 15 years. To provide all the necessary services, we assembled a team of experts in addition to our four core team members. Our expanded team includes:

• Property manager
• Renovation company
• property inspector
• Multiple trades like roofers and plumbers, which we call upon as needed
• Lenders

Not Just Rent Collectors

If your only expectation of a property manager is rent collection, you have extremely low expectations.

We expected the property manager to become integral to our core team. For example, the property manager we work with plays a key part in our property evaluation, in addition to managing our clients’ properties. See the diagram below.

Our core team manages everything until the renovation is complete. After renovation, the property manager takes over. She then does the most important task a property manager provides: markets the property and finds a reliable tenant. Our average tenant stay is over five years, while most other property manager tenants stay for two years or less. This is the difference a good property manager makes.

Our current property manager is our 5th. When property managers’ performance declined, we replaced them. After the first two replacements, being engineers, we developed a process for finding a property manager with the needed skills. This post contains an overview of this process. If anyone would like a free copy of the full guide, DM me.

List Your Requirements

“If you don’t know what you want, you will likely get something else.” paraphrased from Yogi Berra.

Start by listing the capabilities and services the property manager must have. Below are some of our requirements:

• Highly skilled at selecting reliable tenants
• They already manage many similar properties in the areas where our current and future properties are located.
• Already fully automated and has an owner portal.
• Will evaluate potential investment properties and provide estimated rent, time to rent, and renovation items in a timely manner.
• Will handle payment to the HOA and resolve issues between the tenant and the HOA.
• Practively manage property maintenance to keep maintenance costs low.
• Does NOT have an internal repair department. More on this later.

There are several more requirements, but these will give you a start on yours.

Once you have a list of requirements, it is time to find candidate property managers.

Finding Candidates

Search Engines

If you Google something like "Las Vegas Nevada property management companies," you may get too many hits to be practical. Also, ranking high on Google is more of a popularity/marketing contest than any measure of quality of service.

Yelp Reviews

Yelp and similar websites do not include reviews from individuals who benefit from a business's success, such as restaurant owners.

For property managers, other property owners are the clients, not tenants. However, only tenant reviews are typically included. A positive review from a tenant can be a negative review to the property owner.

Some examples.

• "The property manager agreed to replace all the faucets with better-looking ones at no charge!" - Including labor, faucets are about $150 each.
• "They let us stay an extra two weeks at no charge." - Our average rent is $2,200/Mo. Two weeks is $1,100.
• "They gave us back our entire security deposit despite our dog's damage to the rug.” Failing to deduct carpet damage from the security deposit takes money out of the owner’s pocket.

A negative tenant review can be a positive owner review:

• "I lost my job, and I asked the property manager for a couple of free months to find another job. They said no! XXX is a terrible property management company." The property manager did their job by protecting the owner from months of no income.

Always read property manager reviews through the eyes of the owner, not the tenant.

Networking

Reach out to people in your location on sites like Biggerpockets.com and others. Important: just because someone tells you that XXX is a great management company does not mean they will be a great management company for you. Do your due diligence.

Narrowing the Candidate List

Visit each candidate's website. If a website says they specialize in commercial properties and you want to buy residential, cross them off your list. Spending a few minutes on each website before the interviews will save you time.

Interview Questions

Select the best 5 or 10 property managers for an initial phone screen. Prepare 5 to 7 questions. I use one sheet of paper for each interview to take notes. After the interviews, I compared their responses. This helps me identify who knew what they were doing and who was guessing.

First Interview

Consider the chemistry between you and the property manager and their answers to your questions.

Below is a list of possible questions. Many more questions are listed in the guide.

• How long have you been exclusively managing properties? (No part-timers)
• How many properties are you currently managing?
• What is your mix of properties (single-family, condos, commercial, etc.)?
• What geographical area do you service?
• Do you have an internal maintenance department?
• Do you have a staff? How many are full-time?
• What are your fees?

Remove all property managers who did not perform well.

Second Interview

Select 5 to 7 additional questions that build on the initial questions. Again, record all answers for later comparison. Some important questions for this interview include:

• What is the average length of time your tenants stay in a property?
• What is your typical time-to-rent?
• How do you keep owners informed? (monthly statements, website, etc.)

A complete list of interview questions is in the full guide.

Based on this meeting, narrow the list to one or two property managers.

Third Interview

Hold the third meeting via Zoom. Use your previous meetings to guide your questions. Focus on any remaining important issues.

After this meeting, you should have a good property manager.

Additional Considerations

• Choosing the cheapest property manager may cost you more in the long run. A single tenant who doesn't pay rent or causes other problems can be more expensive than the slightly higher cost of a more experienced manager. Focus on the value you get, not just the lowest price.
• Never work with a property manager with an in-house repair staff. They often earn more from repairs than rent collection. Your unplanned maintenance costs shouldn't be another person's primary source of profit. The property managers we work with use services from independent providers for maintenance.
• Do not expect investment advice from a property manager. I've worked with many property managers, and none knew how to analyze a property. The best source of such analysis is an investment realtor (NOT an "investor friendly" realtor).

Summary

Your financial success hinges on your property manager's skills.

Hello @Nick Rivers,

Whether you should keep the property is more complex than the current cash flow. Below are some considerations.

Income Reliability

You stated that you had problematic tenants. This is usually the result of managing your own property. Some people think that the only task a property manager does is to collect the rent, and they do not want to pay for that service.

However, a good property manager's most valuable contribution is selecting reliable tenants. A reliable tenant stays many years, always pays the rent on schedule, and cares for the property. Reliable tenants are the exception, not the norm.

I've worked with many property managers during the 15+ years we've operated our investor services business in Las Vegas. I only know of two property managers with this skill.

I suggest hiring a skilled property manager if you retain the property.

Let me know if you (or anyone) would like to know how to select a good property manager.

To Sell or to Hold

The goal of real estate investing is financial freedom. Financial freedom is more than just replacing your existing income. It's about maintaining your current lifestyle for as long as you live. To achieve this, you need a passive income that meets three requirements:

• Rents must outpace inflation
• Persistent: You will not outlive the income.
• Reliable: The rental income must come every month, even in bad economic times.

Whether rents outpace inflation and how long your income will persist depends on the city you invest in. Income reliability depends on the tenant(s).

The critical component for financial freedom is rent outpacing inflation. So, are rents outpacing inflation in your city?

If rents do not outpace inflation, no matter how many properties you own, you cannot achieve financial freedom. An example will prove this.

Suppose you have a property and the monthly rent is $1,000, the rent growth rate is 2%, and inflation is 4%. What will be the rent's present value (purchasing power) at 1, 5, 10, and 15 years?

First, I will calculate rents at 2% rent growth.

• Year 1: $1,000
• Year 5: $1,000 x (1 + 2%)^5 ≈ $1,104
• Year 10: $1,000 x (1 + 2%)^10 ≈ $1,219
• Year 15: $1,000 x (1 + 2%)^15 ≈ $1,346

Next is the rent's present value (buying power), including 4% inflation.

• Year 1: $1,000
• Year 5: $1,000 x (1 + 2%)^5 / (1 + 4%)^5 ≈ $907
• Year 10: $1,000 x (1 + 2%)^10 / (1 + 4%)^10 ≈ $824
• Year 15: $1,000 x (1 + 2%)^15 / (1 + 4%)^15 ≈ $747

So, in the 10th year, the rent is expected to be $1,219, but inflation reduced its purchasing power to what you can buy today for $824. This is the long-term financial trap of buying properties in locations where rents do not outpace inflation.

If the rents in your city aren't outpacing inflation, consider using a 1031 exchange to a location where rents are outpacing inflation.

Income Persistence

You never want to be in a position where you've outlived your income. The only way for your income to persist is if your tenants remain employed at similar jobs. The problem is that non-government jobs do not last. The average lifespan of a company is about 10 years. An S&P 500 company has an average lifespan of 18 years. So, every non-government job your tenants have will vanish in the foreseeable future. Unless new companies move into the city and create replacement jobs, all that will remain are lower-paying service sector jobs. If your tenants have reduced pay, your rent will stagnate or fall.

What characteristics attract companies to set up new operations in a city?

✅ Low operating costs

✅ Low crime rate

✅ Low risk of a natural disaster

✅ Pro-business regulatory environment

✅ A sufficient population for economic stability. This usually requires a population >1M.

If your city does not meet the above, 1031 should be considered.

Properties and Tenants

Each tenant segment has specific housing requirements and is unlikely to rent a property if it doesn't meet them. The converse is also true. The characteristics of a property determine which tenant segment it attracts.

Are there enough reliable tenants in the segment your property attracts so that a skilled property manager can consistently choose a tenant who will stay many years? Some segments stay longer than others on average.

In 2005, when I selected Las Vegas to set up my business, I did extensive tenant segment research. I discovered that there are three major segments, which I named Transient, Permanent, and Transitional. Below is the average length of stay for each segment.

• Transient: <1 year
• Permanent: >5 years
• Transitional: < 2 years

We target properties in the $320,000 to $475,000 range to attract the Permanent segment. Above about $500,000, properties attract the Transitional segment. Properties that attract Transitional tenants are often unprofitable due to short tenant stays and a longer time to rent. Below about $280,000, you get into a tenant segment that stays, on average, one year or less. Vacancy costs make properties targeting this segment a non-go.

Talk to several property managers. Ask each one about the typical duration a tenant might stay in your property. Also, ask about the time it takes to find a tenant.

I would consider a 1031 exchange if the answers are unfavorable.

Buy Now Or Later

I continue to hear people lament that interest rates are no longer around 3%. They aren't and won't be in the foreseeable future, so we have to deal with the rates as they are.

Prices are rising. Since the beginning of this year, the prices of properties in our target segment increased by 9%.

What will happen if you wait until rates fall? An example will show the problem.

Suppose property prices rise by 8%/Yr, and it takes 5 years before rates fall to 5%. What is the cost of waiting?

I will assume a $400,000 property to have numbers to work with. The table below displays the rising market value from appreciation and the accumulated equity. By waiting, you lose a lot of equity growth, which can not be recovered.

There is another problem with waiting. In five years, prices will be higher, so buying the same property will cost you more. See the table below.

So, waiting 5 years costs you:

• Lost equity: $187,731
• Increased down payment due to appreciation: $56,319
• Higher debt service due to higher prices: $251/Mo

What would happen if you purchased today and refinanced in 5 years?

Also, purchasing today does not necessarily mean negative cash flow. We are still finding properties with first-year ROI between 0% and 1% by putting 30-35% down and or buying down rates. Buying today gets you on the rent and appreciation escalator.

So, I see no advantage to waiting.

Summary

Nick, consider the property's long-term outlook, the type of tenants it attracts, its rent growth rate, etc. Then, decide whether the property can support the goal of financial freedom you desire or if it's time to take action.

Hello @Tanuj Yadav,

There is always the dialogue concerning whether investing locally or remotely is the better option. I believe the answer is not based on rhetoric, it is based on your goals.

If your only goal is to own an investment property, then invest locally. If your goal is financial freedom, then there are stringent requirements for where you invest. For the rest of this post, I will assume your goal is financial freedom.

There are two location requirements for financial freedom.

• Rents outpace inflation.
• The rent continues for the rest of your life.

Here is the problem with investing where rents do not outpace inflation.

I was evaluating a location and determined the average rent growth rate was about 2%. If I assume that the (actual) inflation rate is 5% and the initial rent is $1,000/Mo, what is the inflation-adjusted adjusted rent (or buying power) in 5, 7, and 10 years?

Here is the formula for calculating the future value of the rent.

Inflation-adjusted rent at:

• 5 years: $1,000 x (1 + 2%)^5 / (1 + 5%)^5 ≈ $865
• 7 years: $1,000 x (1 + 2%)^7 / (1 + 5%)^7 ≈ $816
• 10 years: $1,000 x (1 + 2%)^10 / (1 + 5%)^10 ≈ $748

Because inflation is outpacing the rent, every year your buying power declines. In this example, in 7 years, $1,149 ($1,000 increased at 2%/Yr) will only buy as much as $816 will today.

The ugly truth is that no matter how many properties you own in a location where rents do not outpace inflation, you will sooner or later be looking for a job.

What causes rents to increase?

In real estate, prices are determined by the imbalance between the number of buyers and sellers. When there are more buyers than sellers, prices rise until the number of buyers and sellers is roughly balanced. When there are more sellers than buyers, prices decline until the number of buyers and sellers is roughly balanced.

Rents follow prices. When prices are high, fewer people can afford to buy and are forced to rent, increasing demand for rental properties so rents rise. When prices are low, more people can buy, resulting in decreased demand for rental properties so rents fall.

What causes the imbalance between buyers and sellers? Population change.

For rents to outpace inflation. the rate of population growth must be significant and sustained. Also, for the location to be economically stable, a metro population >1M is necessary. Smaller cities tend to be dependent on a single company or market sector. The source for metro population size and population change: Wikipedia

There are more criteria. If you are interested, let me know and I will post them.

Remote Investing

Does remote investing work? Yes, but only if you have an experienced local investment team. Here is the problem. Everything you learn from podcasts, books, seminars, and websites is general knowledge. You will purchase a specific property in a specific location, subject to specific local rules and regulations. The only source for the information, processes, experience, and resources is a local investment team.

We have an investor services business and have delivered over 490 investment properties. 96% of our clients are remote investors; they live in other states or countries. >90% of our clients buy more than one property from us and our largest source of new clients is referrals from existing clients. So, remote investing works, if you have a good local investment team.

And, working with an investment team typically does not cost more than other realtors. For example, of the 490+ properties we've delivered, we only charged our clients a fee on four or five occasions; these were exceptional circumstances. In all other cases, the listing agent covered our fees, not our clients.

In Summary

If you invest in any city where rents do not outpace inflation, inflation will continuously erode your buying power and sooner or later you will be forced back on the treadmill.

Tanuj, I hope this helps. Reach out if I can help, or you can find more investing insights, methodology, and processes in my (free) weekly blog: ericfernwood.substack.com

...Eric

Hello @Nick Virovec,

In my opinion, none of the online sites (Rentometer, Zillow, Redfin, etc.) are accurate enough for evaluating specific properties. In this post, I will explain why and how to obtain the required accuracy.

How Online Sites Estimate Rent

Online sites calculate the average rent per square foot for an area. When you enter the address of a property, the site estimates the rent by multiplying the average area $/SF by the subject property's square footage. For example, if the average $/SF for 3-bedroom homes in an area is $1.10/SF, and the subject property has an area of 1,500 SF, then the estimated rent would be:

• 1,500 SF x $1.10/SF = $1,650/Mo

The problem is these sites do not consider a property's specifics.

Property Specific Examples

Proximity to nuisances - Property A, located next to Interstate 15, will have a lower rental price than Property B, even if the physical attributes of the properties are the same. This is because of the noise generated by I15.

Property condition - Would you expect this property to rent for the same amount as a similar property in good condition?

Age - These two properties have similar sizes and the same number of beds and baths. Would you expect them to have the same rent?

I could continue, but I believe you see some problems with online sites for estimating rent.

Rentometer vs. Actual

I decided to use Rentometer for the following comparisons. Any online site could be used, and the results would be about the same.

I looked up four recently rented properties on the MLS and compared the median Rentometer prediction to the actual rent. As you can see below, the information provided by Rentometer is nowhere near the actual rent.

Next, I used Rentometer to estimate the rent for another property. Rentometer provided a rent range of $1,852 to $2,258, a range of $406.

I then compared the return for this property based on the low, median, and high Rentometer projections. See below.

So, depending on which Rentometer rent estimate you choose, you will either lose $94/Mo or make $312/Mo. Would you be willing to purchase a property with this quality of information? I would not.

What is the best source of property-specific rental rates? Property managers.

How Property Managers Estimate Rent

Property managers largely base rent estimates on current competition. For example, suppose recently rented similar properties went for $2,300/Mo. But, when your property goes on the market, similar properties are available for $1,950/Mo to $2,000/Mo. It's likely your property will rent for around $2,000/Mo, not $2,300/Mo. Rental history is not that relevant when it comes to actual rental rates. Online tools only use past rental data for making rental estimates.

Important considerations:

• The current competition is what determines the monthly rent, not prior rentals.
• Your competition is not necessarily the property down the street. It could also be a property across town, as illustrated below. Prospective tenants who work in the "main job area" consider all properties in acceptable areas with similar commute times.

• Property specifics matter. For example, what if you paint the interior dark green, which is unacceptable to the tenant segment normally attracted to your property? You could only rent it if you decreased it well below market.

Summary

No online site I have seen provides property-specific rental rates accurate enough for making investment decisions. The most dependable source for accurate rent information is an experienced property manager.

We have delivered 490+ properties and never selected one without first obtaining the rent estimate from a reliable property manager.

Nick, I hope this helps. Reach out if I can help, or you can find more investing insights, methodology, and processes in my (free) weekly blog: ericfernwood.substack.com

...Eric

Hello @Julius Clark,

I completely agree with you. Too many people want to “go it alone.” Why? I have no idea.

People think they know how to invest because they read many books, attended seminars, and listened to podcasts. The problem is that podcasts, books, seminars, and websites only provide general information. You will purchase a specific property in a specific city with specific local conditions and regulations. Only an experienced local investment team has the local knowledge, processes, resources, and skills you need to be successful.

Besides, working with an investment team usually does not cost more. For instance, we have delivered over 490 investment properties and charged our clients a fee on only four or five, which were exceptional circumstances. In all other cases, our fees were paid by the seller's listing agent, not by our client.

Your investment is as good as your team.

Hello @Benjamin Sulka,

Just because you can buy a property below market does not necessarily make it a good investment property. Here is the problem.

You buy a rental property to have a reliable rental income. However, the only way to have a reliable income is if a reliable tenant continuously occupies your property. A reliable tenant stays many years, always pays the rent on schedule, and cares for the property. Reliable tenants are the exception, not the norm. And, over the years that you will own the property, you will need multiple reliable tenants.

To maximize the odds of always having a reliable tenant, buy a property that attracts a tenant demographic with a high concentration of reliable tenants.

You can identify a tenant segment with a high concentration of reliable tenants through property manager interviews. If you or anyone would like sample interview questions, let me know.

Once you identify your target segment, determine what and where they rent today. You can create a property profile based on where and what they rent today. A property profile contains at least four elements:

• Location - The locations where significant percentages of the target segment are renting today.
• Property type - What type of properties are they renting today? Condo, high rise, multi-family, single family?
• Rent range - What the segment is willing and able to pay.
• Configuration - Two bedrooms, three-car garage, large back yard, single-story, two stories?

Let the target tenant segment you want to occupy your rental property make all the property decisions. For example, the map below shows where most of our client's properties are located.

I did not select the property type, rent range, configuration, or location. I determined where the segment we targeted was willing and able to rent; the tenant segment effectively made all decisions.

This is how a retail store chooses a location. A retail store identifies its target customer demographic and chooses a location based on where that demographic lives. They then stock the store with what that demographic is willing and able to buy. Companies that do not listen to their demographic lose a lot of money.

If you feel pressed to consider the lake house, I would ask multiple property managers questions like the following:

• Would you buy this property for use as a rental?
• What is the average length of time tenants would stay in this property?
• How long will it take to rent this property?
• What changes are necessary to maximize income while minimizing renovation costs?
• What is a reasonable rental rate for the property?
• Do you have experience managing this type of property?
• Will you be able to rent the property throughout the year, or will it be more seasonal?

After you ask the same questions of multiple property managers, you will have a good idea of the rent, time to rent, and length of tenant stay. Now is the time to use a spreadsheet to determine if the property makes financial sense.

Benjamin, I hope this helps. 

...Eric

Hello @Jennifer Cramer,

You need to look at the city level, not the state level. Which city is best depends on your investment goal, which I will assume to be lifelong financial freedom.

Financial freedom is more than just replacing your existing income. It's about maintaining your current lifestyle for as long as you live. To achieve this, you need a passive income that meets three requirements:

• Rents must outpace inflation: If rents do not outpace inflation, no matter how many properties you own, you cannot achieve financial freedom due to inflation continuously eroding purchasing power.
• Income persistence: Financial freedom requires that your income lasts throughout your life.
• Income dependability: The rental income must continue, even in bad economic times.

The city you invest in determines whether rents outpace inflation and how long the income will last (income persistence). Income dependability depends on the tenant(s), which I will not cover in this post.

What Causes Rents to Increase?

In real estate, prices are determined by the imbalance between the number of buyers vs. sellers. When there are more buyers than sellers, prices rise until the number of buyers and sellers is balanced. On the other hand, when there are more sellers, prices decline until the number of buyers and sellers is balanced.

Rental rates follow prices. When home prices are high, fewer people can afford to buy, so they are forced to rent. This increases the demand for rental properties, resulting in higher rents. When prices are low, more people can afford to buy, which decreases the number of renters, leading to a decrease in rent.

What causes rents to increase? When there are more buyers than sellers. Increasing population increases the demand for housing, which causes rising prices and rents. If the population growth rate is significant and sustained, rent increases will outpace inflation. So, we have the first city criteria.

✅ Significant and sustained population growth. See this page on Wikipedia for population growth data.

Income Persistence

Income persistence depends on your tenants remaining employed at similar wages for as long as you live. However, all private sector jobs are short-lived. The average lifespan of a company is about 10 years. Even S&P 500 companies only have an average lifespan of about 18 years. Every job your tenants have will vanish in the foreseeable future. So, whether your income persists is dependent on replacement jobs. What conditions are necessary to attract new companies to relocate to a city?

✅ Economic stability. This requires a metro population >1M. Smaller cities tend to be dependent on a single company or market sector. Wikipedia 

✅ Low operating costs: The three most apparent costs for investors are income taxes, property taxes, and insurance. Here are the sources for comparison: Tax Foundation, Insurance - ValuePenguin, State Property Tax Rates - Rocket Mortgage 

✅ Low crime rate: Companies depend on attracting talented workers. Talented workers will not move to a high-crime city. Do not invest in any city on Neighborhood Scouts’ list of the 100 most dangerous US cities. 

✅ Low risk of a natural disaster: When a natural disaster hits a city, it destroys jobs, businesses, and homes. This forces people to move to a different city to find work and start over. So, even if your property is rebuilt, there might not be anyone to rent it. Meanwhile, you still have to pay your mortgage, taxes, insurance, and maintenance costs. To avoid this, choose a location with low-cost homeowners' insurance, which indicates a lower risk of natural disasters. Insurance - ValuePenguin 

✅ Pro-business environment: Google search

Elimination, Not Selection

We now have a well-defined set of criteria that a city must meet to make financial freedom possible. The next question is how to use these criteria. Fortunately, there is an easy method based on elimination, not selection.

The process is illustrated below. Start with all cities that match one of the criteria. For example, cities with a metro population >1M. Next, apply each additional criterion to the cities remaining on the list, removing cities that don't meet all criteria.

I recommend applying the elimination criteria in the following order.

✅ Cities with a metro population >1M: Wikipedia

✅ Significant and sustained population growth: Wikipedia

✅ Low crime rate: Do not invest in any city on Neighborhood Scouts’ list of the 100 most dangerous US cities.

✅ Low risk of a natural disaster: Insurance - ValuePenguin

✅ Low operating costs: Tax Foundation, Insurance - ValuePenguin, State Property Tax Rates - Rocket Mortgage

✅ Pro-business environment: Google search

Investment Team

Why is it essential to work with a local investment team? Podcasts, books, seminars, and websites only provide general information. You will purchase a specific property in a specific city with specific local conditions and regulations. Only an experienced local investment team has the local knowledge, processes, resources, and skills you need to be successful. I would consider another city if there is no existing investment team.

Also, working with an investment team usually does not cost more. For instance, we have delivered over 490 investment properties and charged our clients a fee on only four or five, which were exceptional circumstances. In all other cases, our fees were paid by the seller's listing agent, not by our client.

[Let me know if you or anyone else would like to see a process for locating and qualifying a local investment team.]

Jennifer, I hope this helps. Reach out if I can help, or you can check out my weekly blog at ericfernwood.substack.com for more investing insights, methodology, and processes.

...Eric

Hello @Josh Haney,

Buying through a turnkey does not reduce the time or effort required for due diligence. Turnkey is simply an alternative to direct purchase.

The first step is to define your goal. For many, the goal is achieving financial freedom. However, financial freedom goes beyond simply replacing your current income; it entails maintaining your current lifestyle indefinitely. To have lifelong financial freedom, you need a passive income that meets two requirements:

• Rent growth must outpace inflation: If rents in the city where you invest do not outpace inflation, no matter how many properties you own, the erosion of buying power due to inflation will soon be forced to get a job to supplement your decreasing rental income.
• Persistent: Your rental income must last a long time, ensuring you do not outlive your income.

Location Selection

Below are the requirements a city must meet for financial freedom.

✅ Significant and sustained population growth. Prices and rents only rise rapidly if there is sustained and significant population growth. Never buy in a location with declining or static population growth.

✅ Economic stability. This requires a metro population >1M. Smaller cities tend to be dependent on a single company or market sector.

People are drawn to cities for job opportunities; existing businesses must grow and new ones must move in, creating more employment. What are the characteristics that make a city attractive to businesses?

✅ Low operating costs

✅ Low crime rate

✅ Low risk of a natural disaster

✅ Pro-business environment

✅ No rent control of any kind. Rent control is a strong indicator of an intrusive government

If anyone wants the information sources for each of the above, DM me.

Tenant Segment Selection

The only way to have a reliable income is if a reliable tenant continuously occupies your property. A reliable tenant stays for many years, always pays the rent on schedule, and takes care of the property. Reliable tenants are the exception, not the norm. And, over the years you will hold the property, you will need multiple reliable tenants.

The best way to consistently have a reliable tenant is to buy a property that attracts a tenant segment with a high concentration of reliable people. You can identify this segment through property manager interviews. If anyone would like sample interview questions, DM me.

Once you identify a target segment, determine what and where they are renting today. Based on this, you can create what I call a property profile. A property profile has at least four elements:

• Location - The locations where a significant percentage of the target segment is renting today.
• Property type - What type of properties are they renting today? Condo, high rise, multi-family, single family?
• Rent range - What the segment is willing and able to pay.
• Configuration - Two bedrooms, three-car garage, large back yard, single-story, two stories?

Once you have a property profile, you know exactly what to purchase to attract your target tenant segment. If you buy a property that does not match all elements of the segment’s property profile, you will exclude this segment from renting your property, which will likely result in shorter tenant stays, lower profits, or worse.

You are now at the point where you need to decide how you want to purchase the property.

How to Determine the Best Purchase Method for You

Based on your due diligence, you know where and what to buy to achieve financial freedom. Now the question is, which option is better for you: turnkey or direct purchase?

The diagram below illustrates the basic process for selecting between turkey or direct purchase.

Turnkey Due Diligence Questions

The following are considerations/questions to ask the turnkey provider:

• “Can I have an independent inspector evaluate the property?” - Only rely on evaluations provided by an independent licensed property inspector; disregard opinions or statements by the turnkey.
• Do not be fooled by good looks. Turnkeys focus on cosmetic improvements, as these make a property more attractive to buyers. However, cosmetic improvements are typically much less expensive than repairs or replacements for systems such as plumbing, electrical, sewer, or foundation.
• Read the purchase contract. Only what is in the written contract matters; nothing the salespeople say matters.
• The turnkey must provide all disclosures from the prior owner of the property. If they are unwilling to do this, they could be hiding serious (expensive) problems.
• The turnkey must provide the results of any code inspections. Are there any code violations?
• Buying through a turnkey always costs more than a direct purchase. I call this additional cost a convenience fee. See the diagram below. Is the convenience of buying turnkey worth the additional cost?

Turnkeys generate significant ongoing income through property management fees. A property manager is not just a "rent collector"; they are the difference between profit and loss. One turnkey property management group I was researching had over 1,000 reviews and a combined score of just over 1 star. A poor property manager will result in move vacancies, higher maintenance costs, and shorter tenant stays. Below are the questions you should ask.

• “What are your property management fees? Are there any additional fees?”
• “Can I choose the property manager I want, or must I use yours?” If you are required to use their property manager, I would not purchase through them.
• “What is your tenant selection process? “Selecting a reliable tenant is the most important job of a property manager. They should have a clear process and criteria for selecting tenants.
• “What is the cost to find and place a new tenant?” It could be $500, or it could be 1 month’s rent. Whatever it is you need to know.
• “What is the average length of stay for similar properties?” Frequently, the average length of tenant stay is just one year. A follow-up question is, “What is the typical time to rent?” If the average stay is one year and the time to get a paying tenant into the property is 3 months, you lose 20% (3/15) of your annual rent to vacancy. So, if the property rents for $800/Mo, and the vacancy rate is 20%, you are only receiving $640/Mo.
• “Is there a tenant already in the property?” Get a copy of the actual lease and read it.
• “Do you have an in-house repair department?” In many cases, property managers make more money from maintenance than from management fees. This is an inherent conflict of interest. I would not work with anyone who has a vested interest in raising my maintenance costs.

If the turnkey does not provide/allow for all of the above, either find a different turnkey or make a direct purchase.

Direct Purchase

If you decide that a turnkey purchase is not the best option for you, find an experienced local investment team.  An experienced local investment team can provide you with all the in-depth local information and resources you need. If you or anyone would like to know how to select an investment team, DM me.

How much time will it require if you work with an experienced investment team? It depends on the team. I have asked many of our 180+ clients about the total time they spent, from the first Zoom meeting through receiving their first rent. The reported times range between 8 and 12 hours, which includes 3 hours of training. So, if you work through an experienced investment team, your time investment is minimal.

Josh, I hope this helps. DM or post your questions.