Thursday, August 8, 2013

Should I Buy Investment Property Locally?

Today we are hosting our first guest post, ever, from Brandon Turner at BiggerPockets.com.  Brandon reached out and graciously offered to answer a question I'd recently asked about rental property.  His article addresses how, and where, you should look for a rental home.
I’m not a hippie.
However, living in Western Washington, I’m surrounded by them daily and tend to pick up on some of their habits (it’s contagious, apparently.) One such habit is the importance of buying locally grown food – from farmer’s markets, farm stands, and selectively shopping at the supermarket. I understand that it is good for both the environment and my local economy to buy local.
But what about rental property? Does that need to be local, also?

You see, I love investing in real estate. It’s kind of an addiction that I started at 21, and haven’t been able to cure. I firmly believe - if done correctly - buying investment property can be one of the safest and most secure ways to build substantial wealth. However, it’s simply not feasible in a lot of local areas to invest in real estate. For example, trying to buy rental property in New York City is probably beyond the reach of most individuals.
So when is a good time to buy locally, and when is it wise to invest out of the area? This post is going to share my thoughts on this question – since a question within a previous blog post here at DoneByForty inspired me to write it. Let’s get going…

What Makes a Good Deal?

Ask 100 real estate investors what makes a good deal – and you’ll likely get 100 different answers. However, I believe there are several key metrics you should focus on when buying rental property:
1.) Cash Flow – Cash flow is the amount of money left in your pocket after all the bills have been paid. Keep in mind, this also includes taking into account that the property may be vacant X% of the year, and you may spend another X% in maintenance each year. I believe positive monthly cash flow after taking into account ALL the expenses in not optional.
2.) Return on Investment - Once you have your cash flow, it’s easy to determine what your return on investment is. For example, if you spent $50,000 on a small rental house and produce $5000 per year in cash flow – you are sitting on a (cash-on-cash) return on investment of 10%. If you are only getting 2% return on investment … you are probably better off with a savings account.
3.) Location/Investment Type – Additionally, you don’t want to be forced to invest in an area or property where you don’t feel comfortable. Many landlords thrive with low income housing – but maybe you don’t? Others would never think of owning multifamily properties, where others welcome it (I’m one who loves multifamily.) If you don’t understand or are not comfortable with a particular property type or location – don’t invest until you feel comfortable with it.

The 1% Rule

There is a popular metric used by investors known as the “1% rule” which states that a property’s monthly rent should exceed 1% of the purchase price. So, if a property costs $100,000 to purchase – you should be able to rent it for at least $1,000 per month. Many investors actually aim higher, for perhaps a 1.5% rule or 2% rule (some even achieve 3%, though this is very uncommon.) Keep in mind that these rules are only “rules of thumb” to help an investor very quickly analyze an investment property to decide if they should pursue it further. However, the higher the percentage – the higher the likely cash flow.
Personally, I would never buy anything below 1%, but shoot for the 2% mark whenever possible, because I want significant cash flow. However, 1.5% and 2% deals are possible in my location and they are not possible everywhere. (I have to search high and low for them… they don’t come easy.) This is why I would rather focus on the 3 metrics above (Cash flow, ROI, and location/property type)

What Is YOUR Area Like?

So to answer the question “should I invest locally” – you really need to take an honest evaluation of your local area. What kind of deals are out there? What neighborhoods do I know well? How far are you willing to drive? What kind of returns are you looking for?
Learning about your local area is easier today than it’s ever been. You can do most of your research online, discovering property values and rental amounts through websites like Zillow or Craigslist. You can even take a virtual drive by most neighborhoods through Google Street View. Or, you can do it the old fashioned way and just get out there and drive around.
Once you know what your local area is like, it will be much easier to decide if you should invest locally or long distance. If you can’t find deals in your local area that can produce better returns than a savings account – why go through the hassle?
Furthermore, if you don’t have the personality or time to manage rentals and don’t want to learn how to be a landlord and want to hire a property manager to look after everything – then you have even less reason to buy locally.

Conclusion

So, as they say – “different strokes for different folks.” Only you can decide if investing locally is the right choice, based on the returns you want and the position in life you have. I believe if you can find great deals locally – it makes perfect sense to be able to drive by your rental properties and keep an eye on things. Being able to manage and do repairs yourself can definitely save you money and increase your cash flow.
However, if those returns are not possible in your location – don’t be afraid of buying long distance. There are numerous “turn key” companies that exist that will help you find deals, buy property, screen tenants, and manage your investments from a distance.
Do your research either way, and do what makes sense.
What do you think? Leave me a comment below and let’s chat about it!
Brandon Turner is an active real estate investor and the Senior Editor at BiggerPockets.com, the real estate investing social network. For more on getting started investing in real estate, be sure to check out the free online guide, “The Ultimate Beginner’s Guide to Real Estate Investing.”

21 comments:

  1. I just rented out my home - to move in with the BF - and I didn't buy as an investment. That being said, the location is popular. The 1% rule is used here, but as a WEEKLY rent! It's incredible. Sadly, for me, the positive cash flow isn't likely as I have high 'condo fees' for all the services (lifts, pool, bldg manager etc). I'm yet to see if I'll be 'richer' for it, but logic (I think) says keeping it longer than 18 months (how long I've had it) is better than the costs of selling so soon...

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    1. Hey Sarah- thanks for reading my post and commenting! Congrats on the weekly 1% rule - that's incredible! If nothing else, your tenants are paying down your mortgage each month!

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  2. Agree if one can afford buying at nearby locality then it is best as you can manage it better and drive rentals. Never thought about buying it away at distant place. Nice article, Thanks for sharing

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    1. Thanks Rita, yeah - I've never invested at a distance yet, but I know a number of folks who have and they seem to be doing well! Thanks for the comment!

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  3. I've never owned any real estate, nor certainly any rental property, but these all seem like great guidelines. It seems to me like it would be easiest to start out with a local place, just because it would be easier to know the area, know the property, handle any problems, etc. As you get more experienced I would guess that going remote would be a little easier since you'd be more prepared for the kinds of things you'll be dealing with.

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    1. Hey Matt, Yeah I agree. It is really nice to be able to drive by a local rental property and check it out, make sure things are being taken care of!

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  4. Thanks for this post! We've been trying to figure out when/how to buy a rental property, and this answered a few of the questions I had. I'm just getting started in researching this topic, so any help I can get is much appreciated. Thanks again for sharing your knowledge!

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    1. I'm glad it's helped some! Hit me up anytime if you have any questions, I'm always happy to help share what I've learned!

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  5. We own two rental properties and they are both about 5 minutes from our house. I love owning locally because I can keep an eye on them and do a lot of things myself. It certainly makes the whole process easier.

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    1. Hey Holly,

      All my properties are also within driving distance and it is really nice to be able to see what's going on. I'd definitely have a bit of a trust issue if I had to do it from thousands of miles away! That said, if I had a manager I could trust far away, it would probably be fine. Thanks for reading and commenting, as always!

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  6. Just thinking about my own house, getting 1% would be a pretty big stretch...but it might be doable. I like this rule and will use it if I ever buy a standalone investment property. We currently just have our home with the rental unit in the basement.

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    1. Hey DC, yeah it is a really nice quick and dirty tool to calculate cash flow. Personally, I'd aim for a bit higher if possible, but in a good neighborhood with good tenants, 1% should be enough to at least provide some cash flow and ROI. Thanks for the comment!

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  7. In general, I tend not to think that there is one answer for everyone, but for us investing locally in real estate is where our comfort zone lies. (It also helps that we experienced a major RE sale from 2009-2011 in our area.)

    With a local rental, you...
    1 - pay yourself rather than a property manager who might do shoddy work and not look out for your best interests.
    2 - know the oddities of the market. Like with our market insurance costs are INSANELY high. So the traditional 1% rules don't make a ton of sense when rates are so high and you have to insure the place for more than 3.7x what you paid for it. Yes, we insure the duplex we bought in 2010 for $50K for $186K. Not kidding.
    3 - look renters in the eye. It's a lot easier for renters to justify screwing someone they've never met than screwing the nice guy who stops by every couple of weeks to mow the lawn.

    IMHO, if you're going with a rental in a location you don't know without anyone you trust nearby to keep an eye out, why not just invest in the stock market? or a REIT if you really want exposure to RE? You'll be more liquid, be just as hands off, and have a lower risk exposure (no one is going to sue you because they tripped and broke their leg on one of your SPY shares).

    I get that other people might come to different conclusions - different strokes for different folks as you say, Brandon - but this is pretty much our comfort zone for the time being.

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    1. Thanks for the awesome comment! I agree, locally is definitely better when it can be done. I think I'd have to really do some heavy screening for a good property manager before investing at a distance. I'm not a huge fan of REITS (5% ROI just doesn't excite me!) but I totally see your point. Thanks so much for reading and commenting! Best of luck and seeya around the blogging world!

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  8. I really like the 1% rule and had never heard that before. I think I would shoot for 1.5% - 2% to make myself feel secure and like I got a really good deal!

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    1. Hey Alexa, yeah it can be a great little tool, though personally - I definitely would want better. I believe 2% rules can be found, but it's tough - but it's better to buy one 2% deal than 5 1% deals, in my opinion!

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  9. A very interesting article! I am one that feels that buying investment property is a great source for passive income. Like Alexa, I never heard about the 1% rule (I am new to all this, so that explains it) but I find it really interesting. Regarding the distance... I think that owning a rental property somewhere near is better than far away for the obvious reasons. I also think that keeping it small and cheap gives you more chances of it being rented for most of the year, as opposed of having a really expensive cool property that is only rented 3 months per year :)

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  10. Great Post, Brandon and the biggerpockets podcast is awesome, listen frequently. I agree rental property is the greatest investment, for so many reasons.

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  11. I personally think locally is the best place to buy property. The thing about real estate is that it's such a location based investment. Unless you understand the area really really well, you're bound to invest in the wrong places.

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  12. Nice post Brandon. I remember on one of your recent podcasts were the lady was getting almost 3% cash flow on her properties. And I think she was using Prosper/Lending Club to help fund the deals. I have been looking at going out of the local market. In south Florida its just too much competition and prices get crazy.

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  13. Cool post very informative. I just found your blog and read through a few posts although this is my first comment, i'll be including it in my favorites and visit again for sure.

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