Have you ever really looked at some of the debates that go on among real estate investors?
There’s the infamous debate about whether it’s better to buy with all cash or to leverage. There’s the debate about whether monthly cash flow or appreciation is more financially lucrative. There’s the debate about whether wholesaling is really a form of investing at all (oh wait, maybe that’s just me that argues that one). There’s the debate about whether a note that pays a higher percentage than a rental property is actually more advantageous than buying the rental property. And lastly, here’s one of the biggest ones: Is it better and safer to invest in your own backyard than to buy investment properties non-locally to where you live? I think this one and the one about paying all cash versus leveraging probably take the cake for the longest-running debates — with no end in sight — that will forever keep appearing on the BiggerPockets Forums.
Well, what are the answers to each debate, you ask? To help you weigh the answers to each, I’d have to start talking through financial calculations, risk assessments, process explanations, and pros and cons lists of each, but instead I am going to give you only one answer for now. Yes, I understand this isn’t going to help you try to learn about each side of each of those debates in order to be more educated in finding your own stance, but all of that is for a separate article and not the point of this one. This one is geared towards just the single answer, which is:
No decision made in real estate investing should leave you feeling uncomfortable!
For this context, I’m not referring to potentially sketchy deals. I’m not referring to comfort in terms of working with a sleazeball or not. I mean just general comfort, presumably with good deals.
A Real Example of Sanity Issues Using Local vs. Non-Local Buying
In order to explain more about comfort levels, I’m going to use the debate of investing in your own backyard versus investing out-of-state.
I’ve used an example in past articles about buying a rental property in Atlanta versus a rental property in Los Angeles. I am tempted to use the same example because I know the actual numbers, and it plays into this point about comfort and sanity quite well. I’m hesitant, however, to use this example because there is the factor of appreciation potential with properties in Los Angeles, which could highly skew the decision as to which property to buy. In layman’s terms, Los Angeles is a hot spot for buying for appreciation potential, which some may argue can be more financially advantageous than buying a property for monthly cash flow. For now, let’s just focus on the cash flow aspect of rental properties in both locations and I’ll bring in the appreciation potential to some extent as we go.
When I was buying my first investment properties in 2011-2012, I was living in a townhouse in Los Angeles. I knew the owner, my landlord, and she and I had talked numbers on that townhouse. She paid $460,000 for it, and I was renting it for $2,250/month. It was a really cute townhouse, about 1,000 square feet with two bedrooms, two and a half bathrooms, and two stories. At the same time I was living there, I was looking at investment properties in Atlanta. One of the properties I ended up buying was a 2,200 square foot house with four bedrooms, three bathrooms, and two stories. The purchase price on it was $95,000, and it was rented out at $1,300/month.
Let’s look at these two properties:
- Atlanta Property: Purchase for $95,000 and rental income of $1,300/month
- Los Angeles Property: Purchase for $460,000 and rental income of $2,250/month
Without going into the nasty depths of running numbers (but if you want to understand better how to calculate rental property numbers, check out “Rental Property Numbers so Easy You Can Calculate Them on a Napkin“), I can tell you that the Atlanta property would leave money in your pocket each month, and the Los Angeles property would not.
The mortgage on the Atlanta property, including the mortgage, taxes and insurance, is just under $600/month. That leaves $700/month in leftover profit, and then after taking out expenses such as property management and estimates for repairs and vacancies, I am still left with a few hundred per month cash in my pocket.
The mortgage on the Los Angeles property, including the mortgage, taxes and insurance, doesn’t even get covered by the rent I was paying. The taxes on that townhouse were the real deal-killer (~$6,000/year versus about $1,000/year on the Atlanta property), but regardless, that mortgage payment came out to be about $2,500/month. Then there were HOA fees on top of that, and then add in estimates for vacancy and repairs, just as you did on the Atlanta property, so you’d be looking at $2,800-3,000/month. Note, however, I’m not including a property management fee on that one because assume you would only buy the Los Angeles property because you are an LA local and want to buy something near you, so I assume you would manage it yourself.
Now, this appreciation thing. Most definitely, that Los Angeles house has significantly more appreciation potential than that Atlanta house, so if you are really investing just for appreciation, that Los Angeles townhouse would be the way to go, assuming you buy at the right time. Otherwise, that appreciation may not turn out quite as planned.
From a cash flow standpoint only, though, the Atlanta property blows the Los Angeles townhouse out of the water.
What if you live in Los Angeles and you are the one weighing these two options as potential rental property investments? The Atlanta property will put a lot more money in your pocket each month, but the Los Angeles property is local to you. The only hope you would have with that Los Angeles property, in terms of profit, is if it appreciated significantly enough to make up for hundreds of dollars lost on it each month. That is very risky. But Atlanta is 2,200 miles away! And you would have to trust other people to handle the property for you, such as a property manager.
Which Do You Buy?
Well, from an investment standpoint, the Atlanta property is less risky and presumably more profitable because it is giving you solid cash flow each month with a great margin for unexpected expenses, while the Los Angeles property is highly risky because you are losing money each month and you can only speculate as to its appreciation potential. Actually, this talk about appreciation potential is playing perfectly into what I’m driving at, now that I think about it. So let’s break down these two options, now that you have some background on how each would work:
- Atlanta Property: Least risk because cash flow is solid and lower capital investment.
- Los Angeles Property: Highest risk because the only hope for profit is with substantial appreciation, which is speculative, and has a much higher capital investment required.
The Atlanta property has the least risk because it’s built on solid investment fundamentals and has significantly less money required to buy into it, and the Los Angeles property has the highest risk because any profit it may see is purely speculative and it requires a huge amount of capital to buy into it.
But wait. Isn’t one of the biggest arguments against buying out-of-state investments risk? People who are uncomfortable buying properties that are out-of-state see a high risk factor in buying properties that they have to rely on other people to manage for them and that they can’t drive to. This is in contrast with the feeling of security if they are able to drive by their own properties and/or manage them themselves.
Again, as tempting as it is to jump into the debate of buying locally or not locally, that is not my point for right now. Here is the part where I want to take appreciation potential out of the equation, because this scenario may easily pop up in areas that don’t have appreciation potential like Los Angeles does. So looking only at cash flow potential with both of these properties, it is clear that the Atlanta property is the winner, and the Los Angeles property would only drain your pocket (and at a fairly rapid speed, at that). But you live in Los Angeles and you are far away from Atlanta.
On paper, the Atlanta property is the only one that makes sense. You can profit greatly on the Atlanta property, in terms of cash flow, and you will lose money left and right on the Los Angeles townhouse. Does that mean that you should, in fact, buy the Atlanta property? Yes, unless you just aren’t comfortable buying so far away from where you live. I could give you reasons all day long to try to convince you that buying out-of-state is not as risky as it seems, but the reality is, no matter how much education you get on it and no matter how much money you might lose on that Los Angeles townhouse, you may just not be able to stomach the feeling of owning property so far away from where you live. Period.
If that’s the case, buy the Los Angeles townhouse. As long as you are educated fully and understand the ins and outs of each buying opportunity, and you thoroughly understand the risk associated, and assuming you just insist on owning a rental property, and yet you are still freakishly uncomfortable buying outside your local area — buy the Los Angeles townhouse. Maybe appreciation really will kick in and it will turn out to be a great investment, but even if you lose money each month, I would rather you lose money each month than chunks of your sanity.
No matter how good an investment opportunity may be, and no matter how profitable it may be, it is never worth your sanity!
If you are going to be stressed out and nervous and itchy about any deal, don’t do it. Real estate investing is not meant to shave years off your life and give you migraines in the meantime. No amount of profit or returns is worth that!
My caveat here is that the first goal, with any investment opportunity, should be to get fully educated. Being nervous about an investment opportunity before you are fully educated doesn’t count. Only when you have a full understanding of the numbers, the risks, the pros and cons, and everything else, can you make an accurate assessment regarding your nervous level.
Of course, I will tell you all day long that buying in Los Angeles for cash flow is a bad idea and that you can find actual cash flow elsewhere. But if you tell me, after you are fully educated on the ins and outs of both options, that you just can’t stomach buying somewhere that you can’t drive to, I will support you all day long in foregoing the better cash flow elsewhere and buying where you are comfortable. Because, as I said, no investment property is worth a drain on your sanity.
Side note: Ironically, and contrary to what most would see as being the sanity-drainer about buying outside your local area, I only buy out-of-state properties because the thought of being able to see my properties and wondering about them day in and day out just makes me cringe! I’m too much of a perfectionist, and I’d worry way too much about the properties to be able to be that close (literally and figuratively) to my rental properties. My sanity would be so far gone, it wouldn’t even be worth it. I like the “out of sight, out of mind” concept for rental properties, which is the only way for me to keep my sanity! You may be completely different, so most people probably are, but we are all different and we all have different sanity-triggers. Make sure you know yours!
Experienced investors: How do you keep your sanity in check when investing? What are you comfortable with versus not? Where do you draw the line when it comes to whether a property is worth it or not?
Be sure to leave a comment below!
*Note: the numbers I used for the Atlanta and Los Angeles properties were 2012 numbers. I know for sure the Atlanta numbers don’t reflect the current market, and I’m really not sure about the Los Angeles market.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.