Real Estate Investing – Local Or Far Away – The Common Denominator
Last week’s post about the decision, or rather preference real estate investors have for where they invest, delivered a priceless comment thread. Those who preferred the best market possible in which to invest were met, point for point by those who wouldn’t leave their local market if the Lord Himself came down and ordained it. In a word, it was fantastic. Better yet? That comment thread demonstrated a common bond between the two clearly divided schools of thought.
We can talk all we want, but for the most part when it comes to investing in real estate for the long term, we figure out ways to remain in our personal comfort zones. Sometimes even empirical analysis won’t budge us — first hand observation won’t change our minds. Sometimes it’s the natural consequence of how we were originally taught, even mentored. Other times it comes from within.
The key factor we all must understand is that there IS no wrong answer — with one glaring exception.
We can’t be made to violate our comfort zone. Period, end of sentence. If an objective reader could glean anything from that thread, the obvious existence of the commenters’ comfort zones was it.
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Think about it objectively for a minute.
In fact, I’ll go first. How difficult do you think it was for me to completely abandon my own market, professionally speaking, almost a decade ago? The reason I took that drastic step was that by all objective analysis I wasn’t doing investors any good by telling them San Diego was still a ‘great market in which to invest’. It simply wasn’t true any longer, not matter the method of analysis employed. The comparative analyses using several different far away markets was damning to say the least. My life was a mess for two years due to that decision. Folks thought I was, um, misguided to say the least. Now? Not so much.
But don’t take my word for it.
If you wanna get started as a serious long term real estate investor in San Diego, here’s what you’ll find. Let’s start with a modestly priced and relatively well located duplex, a few minutes from my office. Let’s take the one in which my own daughter now lives. It was built around 1952. Its floor plan is laughable. The kitchen? The poster child for functional obsolescence. Prices in San Diego have consistently gone southward on the chart since the original bursting of the bubble, with one short, mean-spirited exception. At the top, these duplexes consistently sold in the range of $540-575,000. Now? There are a few on the market for between $325-360,000. Their rents are roughly $2,400-2,600/mo total.
At say, $350,000 using the required 25% down, the investor would need $87,500 + closing costs. Let's call it $95,000, give or take. What you get, to cut to the chase, is a 75% loan at the current investor rate of 4.625%. That's an annual debt service of about $16,200. Rents are $31,200 a year. Using a vacancy/operating expense factor of 40%, we come up with a Net Operating Income of $18,720. That means that our cash on cash return is $2,520 annually â or, if you prefer, 2.65%.
The same thing in a state almost three hours away by air offers the following menu option for this first time investor.
This duplex is brand new. The monthly total rents are about $2,700. The location quality is empirically superior to the San Diego example. They offer 2-car garages for both tenants. In San Diego the tenants share a 1.5-car garage. The kitchens in the other state are state of the art, as are the floor plans. And the list goes on. The price for this outa state property is about $263,000 or so. Let’s see how it compares to San Diego’s offering.
25% down + closing costs = around $73,000, give or take. If we use a 50% vacancy/operating expense factor (25% more than we allowed SD’s duplex), the cash on cash return would be around $4,030 — or roughly 5.5%.
This newbie investor’s first investment will require either $95,000 — or — $73,000 initial cash. The San Diego duplex’s cash on cash return will be less than half of the outa state option. Also, just to make a point, I actually used less vacancy and operating expenses on a half century old property than I did with the brand new duplex. Yet the far away property slaughtered the cash flow by doubling the cash flow of it’s ancient San Diego cousin.
Now do you understand why I left my hometown’s real estate investment market? I couldn’t look folks in the eye while advising them to keep their hard earned capital in the ‘I can drive by them’ market, hometown or not.
Yet when I told my clientele of my intention to abandon San Diego’s market, just under 35% of them bought into my analysis. The rest chose to remain. Their almost visceral need to drive by their properties overcame objective analysis. Put more fairly, they would not violate their comfort zones. At the time I supported their decisions without reservation. Since then some have had a change of heart, but most remain deeply committed to San Diego. This, in the face of massive loss of net worth, cash flow, and the sinking feeling that their cash flow projections for retirement have been gutted.
Does this one example prove anything about the pros and cons of investing local or far away? Not in the least. Your particular market might be close enough for jazz compared to other, sexier markets. There’s nothing magical about either school of thought. The only school of thought that matters a wit are two:
1. We must all steadfastly remain inside our own comfort zones. We can expand those zones by our own volition, but we must remain inside them.
2. The consequences of the investments made, dictated by those same comfort zones may not be as comfortable as we’d hoped — yet they will remain the consequences.
And there’s the rub
For decades, investment capital flowed into San Diego like an overflowing waterfall from not only all parts of the nation , but of the world. That same capital is now headed elsewhere, and for good reason. If someone had come to me at any time between 1976 and 2003, with the goal of convincing me there was a superior market to San Diego? I’d of laughed out loud — and I had the empirically historical numbers to back up that mirth. Our market rocked!
Stay in your comfort zone for sure. But try this at the same time. Test your comfort zone as it relates to the ultimate consequences of your decisions. Will this investment decision have a deleterious affect on your retirement income, relatively speaking? The answer to that question is often the catalyst for the expansion of our comfort zone.
Again, there’s nothing magical about staying local or going far away. Just ensure you understand the end game results as it relates to your retirement income. After all, that’s why you chose real estate in the first place, right?