Buyer Beware: 3 Essential Items to Vet BEFORE Investing Out-of-State
There has been a lot of discussion on BiggerPockets and elsewhere on how to and whether you should buy out-of-state (see here and here for example). I certainly understand the temptation, although I should note that temptations are often for things we should avoid. I, for one, came from a West coast city (Eugene, OR) to a Midwestern city (Kansas City, MO) and have seen both sides of investing out-of-state.
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On the one hand, it makes sense because in certain places, such as California and even my home of Oregon, real estate is just too expensive to rent out and make it pencil. After all, the average price of a home in San Francisco is just under $1,000,000 and about three quarters of the city is rent controlled. However, buying out-of-state is very risky, and I have seen a lot of hard-earned equity go the way of the Dodo bird through out-of-state investing.
One memory it particular springs to mind of a man who stopped by our office asking if we managed properties (we do, but only our own). He had bought two houses out-of-state at highly inflated prices from an extremely shystie company and then paid them even more for the rehab. When they stopped returning his calls, he came out to Kansas City and found that both properties stood in the worst part of town and hadn’t even been touched. I have rarely seen someone look so defeated, and telling him there was nothing we could do was a difficult task to say the least.
I know another who got stuck with a 50-unit complex that took three years and three managers to turn around (with "turned around" still being a bit of a euphemism). Another lost two fourplexes to foreclosure. The owner of a short sale property we bought found our website and the part that mentioned "we buy distressed and undervalued property," and she almost had a panic attack (we bought the house for about half of what she did. A real estate agent friend of mine used to work with a hedge fund that raised money from out-of-staters to invest in properties throughout the Midwest that eventually went bankrupt. The list goes onâ¦
Needless to say, unless you own an investment company that is more national in scope, out-of-state investing is something I would shy away from. It can be done, and it can be done profitably, but it’s much riskier than staying close to home.
If you do want to risk it, here are some key things to do.
3 Essential Items to Vet BEFORE Investing Out-of-State
Vet the Team
Regardless of where you are, you need to do this, but even more so when dealing out-of-state. There are, unfortunately, some unscrupulous types that prey on out-of-state investors’ ignorance. Just because a property is cheap doesn’t mean it’s a good deal. You must erase the assumptions you have about real estate prices from your home market. If a property costs $30,000, it may sound like an insanely good deal, especially if similar houses where you’re from cost $500,000. But if the neighboring houses cost $20,000, it doesn’t really matter what houses in your home market cost.
When vetting a team, ask around to find a property manager. If you’re working through some all-in-one agency, don’t just take the manager they recommend. Furthermore, interview whomever you choose thoroughly and ask for references. Do the same with any contractors you use. From what I’ve seen, it’s usually unwise to have the same company that you bought the property from do the rehab; it can be a conflict of interest. And make sure to visit from time to time to keep them accountable and make sure everything looks right. Finally, do not be afraid to switch if they are not getting the job done!
Vet the Property
Many people from California or other high priced markets are so blown away by the price difference and potential return (key word: potential) they assume they must be getting a good deal. But often these properties are in the middle of a war zone, and the potential return can just be a bunch of made up numbers. Some of these areas are what a friend of mine calls “rent optional.” As a quick rule of thumb, if the pro forma cap rate is over 20, it’s made up. I guarantee it.
So call a Realtor or two to get a CMA (comparative market analysis) and their advice on these areas (or a different Realtor if you are working with a Realtor already).
Zillow is also a good place to look for values, but remember the Zestimate is usually high. Same goes for EAppraisal. Look for the nearby sales, and compare that to your prospective property; don’t just look at whatever value some algorithm shot out. Also look at the rents. Rentometer is a fine place to start, but real comps are better; Hotpads and Craigslist both have map features now that allow users to easily find comparables. RentRange is even better, although it costs money.
If there is already a tenant, make sure to get an updated rent roll, proof of payment (like a bank statement) and preferably (although you’ll need the tenant’s permission) a copy of the tenant’s background report.
Do not trust a seller’s repair estimates — it’s always more and usually a lot more. It’s not uncommon for me to triple seller repair estimates when doing the estimate myself. Even when sellers are trying to be honest (and yes, most are honest), it’s usually low because people are overly optimistic. The Sydney Opera House was supposed to cost $7 million, but ended up costing over $100 million! Look at the property in person yourself, and try to get a contractor bid or at least a rough estimate. And remember, that bid will usually not include appliances, HVAC, carpet and cleaning. There will also probably be a few change orders and add ons, so add in a contingency to your budget (15 to 20 percent).
Vet the Area
Finally, some bad areas can be deceiving even when you are there in person. The movies make these areas appear completely hopeless and while some are, others do not look that bad on the surface. Ask around and visit websites that have crime and income data. City-data has a map feature that can break down income and other demographics (although unfortunately not crime) by subdivision. And CLRSearch and Homefair have zip code crime data. I’m not a huge fan of the crime mapping sites, such as CrimeReports, because I am quite confident they don’t have complete data, but they are worth looking at as well.
Do not skip this step; you absolutely do not want to own a property several states away in the middle of a war zone. The A/C will get stolen, the tenants will trash the house, etc. The rent (when it comes in) will rarely cover the turnover and rehab. To make money in these areas, you really have to specialize in it. It can be done, but there isn’t a manager on Earth I would trust in rough areas, especially several states away.
Again, for the most part, I recommend staying close to home. And while careful due diligence is always important, when investing out-of-state, it becomes exponentially more so. So if you choose to risk it, make sure to be very careful indeed.
Time for you to weigh in: What has your experience been investing out-of-state? Or is this something you would never attempt?
Leave your comments below, and let’s talk!