Don’t Buy Property Outside of Your Immediate Geographical Area Unless You Do These Things First

I love talking about real estate investing strategies as much as I love talking about real estate tax strategies, so in this article I want to focus on the concepts you need to consider when you are buying out of your area such as an investment in an out of state property that you cannot normally drive to easily.

The Lure of Out of State Properties

As a native Californian, I have grown accustomed to ridiculously high prices for real estate. Whether it’s the $1MM entry level homes or the $3,000 monthly 1 bedroom apartment, I’m always taken aback by how much more affordable property is in the rest of the country. I discussed some of the core reasons why housing is so unaffordable in California.

Even if the numbers pencil on a $1MM investment in California, the biggest issue first time investors face is having enough cash on hand to fund the equity. In a typical investment that might require a 20% down payment, that’s still a $200,000 check that needs to be written! Very challenging to save up that money while competing with an extremely high cost of living that’s constantly battering down your savings account.

But what if you could write a $20,000 check on a $100,000 investment? Much more doable, right? This is the primary selling factor of buying out of state from residents in high market areas and I can understand why!

Before writing that check though, I encourage you to consider the following.

Management

I’ve mentioned why property management is so important in your real estate investment strategy. I would argue that management is even more important than your analysis of the numbers and the economics, because you can have the best plan on earth and without a proper execution strategy, you can wind up upside down in your deal very quickly.

Buying properties outside of your immediate geography can work, but only if you have scale. When considering that $100,000 investment, which is most likely a single family home in a secondary or tertiary market, how much rent would you generate per month? Probably between $800-$1,000/mo. If you find one that generates much more than that (as a long term rental, Airbnb doesn’t count), you can contact me directly and I’ll be happy to co-invest with you. Let’s assume $1,000/mo is the rental rate. If you hired a good property manager, how much would you pay them to keep your property in top shape? Even assuming a 10% management fee, that’s $100/mo. Even in low cost of living markets, that’s not a lot of money to make anyone in particular very excited to protect your investment. Considering it takes the same work to property manage a $1,000/mo unit or a $10,000/mo unit, you can see how this can be a huge problem down the road. I’ve seen clients invest in property during an increasing market out of state and sold at the peak at a loss because of repair issues, poor rental collection and squatters because the management wasn’t that motivated to go out of their way to earn the $100 fee.

I’m not trying to scare you away from making this investment, but in acquiring property like the above example, you should consider mitigating risk by co-investing or teaming up with local folks to that market and have your property join up with several others so that management has more incentive to take care of your property. Perhaps if your home was one of 20 properties in a geographical area, it would be much better taken care of than if yours was alone.

Alternatively, at least having family or close friends in that area could help a little more. Short of having this in place, I’d strongly recommend avoiding these markets until you can make a bigger investment.

Appreciation and Upside

Affordable, lower cost markets tend to have similar characteristics, in that the barriers of entry for capital and entry to the market are low. These markets tend to have developer friendly rules, low regulation on rents, and generally more landlord friendly policies. Inversely, high market areas tend to be the opposite.

I am a firm believer that the key to affordability is to lower barriers of entry and provide as many incentives as possible for private developers to build tons of properties at scale. The delivery of more units would drive down housing costs which would benefit society as a whole. Since high market areas, such as the major cities in California, do not have such an environment, costs continue to rise as demand outstrips supply. This is a basic economic concept. However, the upside to this as an investor is that your property will rapidly appreciate in high market areas since there will be very little competition in the form of new housing in the pipeline. I’m sure we’ve all seen the story of that family that bought a modest home in 1994 for $190,000 and sold it in 2022 for $2,500,000 in Los Angeles.

However, in the secondary and tertiary markets, you rarely if ever see this type of appreciation. That $100,000 home you bought in 2023 will probably sell for $110,000 in 2035, unless something dramatic happens to the neighborhood, like Google decides to relocate their headquarters right next to your property. So if you’re expecting the same outcome as a property in Los Angeles for your investment, you will be sorely disappointed. Most likely the cash flow will make you happy and you’ll have to just make do with that.

Summary

When considering going out of state, you need to balance out your desire for investment appreciation and cash flow. You also need to heavily consider how you will execute your investment strategy through property management and at the very minimum build your network to achieve it.

There are many more considerations to factor in when going out of state and I’ll share more with you in the future!

If you want to discuss your real estate strategy for out of state properties, feel free to contact me.

-Stephen Morris, CPA, MBT, CCIM