How You Should (& How You Definitely Shouldn’t) Invest in a New Area
There’s a big debate amongst real estate investors regarding whether it’s best to invest in your home market (even if it’s very pricey) or to buy in less expensive markets out-of-state. I generally lean toward the former, but I certainly understand the latter. It’s almost impossible to find a buy-and-hold rental in San Francisco or New York that will actually cash flow. But if you intend to buy out-of-state, or even if you are looking to buy in a city you just moved to, there are several important steps to take. But first, let’s talk about the steps not to take.
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How Not to Invest in a New Area
When I first came to Kansas City, we ended up buying a 29-unit apartment complex that didn’t go well at all. The reasons were simple:
- We took lessons from the market we left to this new market.
- We didn’t do sufficient due diligence on the area.
1. Taking What You Know From One Market to Another
This is a mistake that is extremely common. Indeed, while there are plenty of good turnkey companies out there, the unscrupulous among them almost always take advantage of the price differential of the market they are selling in and the market the buyer lives in to make it look like they’re selling properties at a good price when really it’s a highly inflated one.
I am from Eugene, Oregon, where we had been flipping houses for some time before we came out to Kansas City to get back into buy-and-hold. In Eugene, the cheapest house you were going to find then (2010) was about $125,000. In Kansas City, we were seeing houses sell for $20,000!
Now, we weren’t stupid enough to think these were equivalent. But like many other investors, our eyes lit up, and we assumed that at such a ridiculously low price, this had to be a good deal!
Somewhere, Ben Leybovich shook his head in disgust.
It’s critical to remember that each market is local. The exact same house could sell for $2,000,000 in Los Angeles and $20,000 in Detroit. Furthermore, as I like to say, “A roof costs the same per square foot on a $30,000 house and a $300,000 house.” In some areas, the fixed costs to maintain a home will be higher than the rent. This is especially true since worse areas are more likely to have tenants that will smash up a property.
2. Insufficient Due Diligence on the Area
While we didn’t really do sufficient due diligence on the apartment either (see here for a guide), the more common problem for investors who are new to an area or from out of state is doing insufficient due diligence on the area. And this is where we really failed on that 29-unit apartment.
This falls hand-in-hand with the first problem, but it plays into a different psychological temptation. The first problem had to do with applying old lessons to new situations, this one has to do with taking the wrong lesson from what you see.
You absolutely should visit any city you plan to invest in and any property you plan to buy. But that’s not enough in and of itself. A lot of areas look decent when you go by them during the day. They especially look good on Google Earth. There’s something about a still frame that makes an area look better. You don’t hear the sounds, smell the trash, or see junk blowing in the wind. For example, the intersection of Independence Avenue and Prospect Avenue was named one of the “20 Worst Streets in America” by Hously. The article notes, “The zip code 64106 that lies at the intersection of the Independence Avenue and Prospect Avenue, Kansas City, Missouri, is one of the worst in the nation. As per the latest statistics, the area experiences 82 violent crimes in a typical year with the official crime rate being 81.97 per 1,000 people.” Yet, here’s a Google Earth image of that intersection:
Doesn’t look that bad to me.
And while visiting is far better than just looking at pictures online, it can still give you a false impression.
What You Should Do
The steps you should take to evaluate a potential market and area are as follows:
- Use online tools to evaluate the city and area
- Visit the area and property
- Ask professionals and locals
- Find and vet a team
- Keep checking back in
1. Use online tools to evaluate the city and area.
The first step to take when evaluating any market you’re just moving to or looking to invest in from out of state is to evaluate it online. You want to evaluate both the city as well as the local areas you’re interested in. A few good, free websites for demographics include City-Data, CLRSearch, and HomeFair. For determining property values (if you can’t get access to the MLS), check out Zillow, EAppraisal, Trulia and Realtor.com.
There are many other websites with more specific data, such as school ratings and walkability scores. There are also paid sites that offer even more detailed information. For more on this, see this article.
Overall though, you want to make sure that the crime isn’t too high, the poverty is relatively low, there isn’t a high rate of vacancy or unemployment and the schools are decent. You want to make sure you are buying a neighborhood that people will want to live. For those buying out of state, I would always recommend you buy at least one class higher than the lowest you would consider where you live. So if a C+ property is the worst you would consider where you are, don’t go below B- or even B if it’s out of state.
2. Visit the area and property.
Make sure to visit the property and understand that, as discussed earlier, looks can be deceiving. Look for things like boarded up or burnt out houses nearby, trash on the street, overgrown lawns, graffiti, lots of people loitering about during normal working hours, etc. Even small things, like very few wooden privacy fences and a lot of chain link fences at least imply the neighborhood is mediocre if not worse. You can also drive by at night. This will very often give you a good idea of how nice the neighborhood is.
And of course, make sure to inspect the property itself closely as well.
3. Ask professionals and locals.
I would always recommend you talk to the tenants (if the seller allows you to), neighbors, and passersby in any area you are unfamiliar with, even if you’ve lived in that city for a long time. Ask open-ended questions, for example, “How do you like living here?” “Have you had any crime issues?” and “What’s the biggest problem you’ve had living here?” Most people will be honest with you and will help paint a picture of the area’s quality.
You can also talk to professionals such as real estate agents, other investors, and lenders. They should have some valuable feedback as well.
4. Find and vet a team.
Vetting your team is too large a topic to go into in here. But if you are looking to buy out-of-state, this article should help with that.
5. Keep checking back in.
Don’t think that just because you’ve bought a property and put it with a management company that the issue is done. You will constantly need to evaluate how well a property is doing financially and how well your staff or the management company you hired is doing. If you live out-of-state, you should visit from time to time to make sure everything is on the up and up (and keep your team on their toes). And don’t be afraid to fire someone or switch management companies. People usually wait too long to do what they know they need to do. If you know the management company you’re using isn’t working out, make the switch.
Overall, the key to investing in a new area is to do your research and NOT go with your gut… at least at first. Your gut is attuned to a different market. You need to tune it to the one your looking at before relying on it. (And you should always verify your gut feeling as best as possible before making decisions based off it.)
Come in with an open mind, do your research and then make the best decision you can from there.
Do you have experience investing out-of-state? What tips do you have to share?
Tell us below!