How to Choose an Out-of-State Market for Investment (in 3 Easy Steps!)
You’ve decided, for whatever reason, that you want to invest outside of your local area or state. Your next question is—where should I invest?
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I’m going to offer you a list of things that you can consider when trying to figure out what market to invest in. These things are in no particular order, and some of them may not apply to you or your particular situation. My intention with each one is to give you something to think about and hopefully some ideas on where and how to start looking for what market you want to invest in.
Here we go!
Step #1: Narrow Down Your Market Options
First, if you are brand new to out-of-state investing and don’t have a clue where to start, your location choices are likely going to feel extremely overwhelming. I have two things for you to think about that will hopefully at least get you moving in some kind of direction:
Where do you have friends and family?
Are there any cities where you have friends or family who might be good assets to have on your “team” on the ground? I’m not necessarily saying go into business with your friends or family or make them an official part of the team, but if you already have ties to any particular cities, maybe take a little time to decide if any of those cities might be good ones to get started. Even if your friends or family there aren’t part of your team, they may be able to occasionally drive by your property once you own it and tell you if anything crazy seems to be going on. It never hurts to have an extra set of trustworthy eyes on an investment property!
Where are other investors buying?
Thanks to technology and the internet (and websites like BiggerPockets!), you can easily and quickly network with other out-of-state investors. Ask people what markets they are buying in, and if they seem friendly and interested in chatting more, find out why they are buying in those markets. Don’t struggle to reinvent the wheel when experienced investors are already out there succeeding with out-of-state properties. I did secretly throw a keyword in there—experienced. Don’t take just anyone’s word for what they claim to be a good city to invest in, but remember, you’re just trying to get a list started. You can dig into details later as you go along.
Start there. Make a list of what cities come up when you consider those two things. Again, this isn’t your final list, but at least your list is much shorter now than it was when it had all 19,354 U.S. cities on it as investing options. You may not have known you had a list of 19,354 cities on it, but if you were starting from scratch, the whole country was a possibility! That would have to be intimidating and overwhelming—and almost an impossible point to start from. Now you have a less intimidating starting point.
Related: What Moving Out of State is Teaching Me About Remotely Managing Rentals
Step #2: Analyze Those Markets
So, now you are looking at your list of some number of cities or major markets on it, and now your question is—how do I know a good city to invest in from a bad city?
In my mind, there are only two major questions I ask to determine whether I want to invest in a particular city:
- Do the numbers work?
- How likely am I going to be able to sustain those numbers?
If you don’t know what numbers I’m talking about, I’m talking about your returns. Returns (a.k.a. profits) can happen in two major ways: cash flow and appreciation. This is at least true for rental properties. If you are flipping out-of-state, some of this will be different for you and there are some slightly different considerations that you’ll need to incorporate into your analyses. You’re on your own, though, for those, as I’ve never flipped so I definitely shouldn’t be the one to tell you how to rock that method out.
Most likely, if you are wanting to invest out-of-state, you’re probably doing so because you want cash flow. Most of the investors who invest out-of-state do so because the numbers locally don’t pencil out. This is often the case in a lot of the bigger markets—Los Angeles, San Francisco, New York, etc. And while those markets don’t usually pencil out for cash flow, they are the bigger players when it comes to appreciation. So, in thinking of anyone who lives there and wants to buy out-of-state, it’s probably because they want cash flow. See my logic?
Either way, let’s assume you are going after cash-flowing rental properties out-of-state because you can’t find cash flow locally. If that’s the case, the numbers need to work in the market you choose to invest in. Otherwise, what’s the point?
So, let’s think about the numbers. What kind of numbers do you need to understand when it comes to cash flow?
If you are in it for cash flow, you want to be able to determine the projected cash flow on a property. To help you do that, use the easy formulas in this article: “Rental Property Numbers so Easy You Can Calculate Them on a Napkin.”
In addition to the equations in that article, a term you will want to be familiar with is “price-to-rent ratio.” This term compares the price of a property to how much rent it can collect. The reason these two things matter is because they will determine whether you can cash flow on the property or not. As you saw in those cash flow equations, you need the rental income you collect on a property to surpass the expenses of buying and owning that property in order to have positive cash flow. If the expenses of buying and owning that property are higher than the rent you can collect from the property, you’re in a negative cash flow situation and losing money, on the cash flow front at least.
Knowing this term now, if someone asks you if you’re interested in a particular market for investing, your first question might be—how are the price-to-rent ratios there? What you’re ultimately asking here is—is there an option for cash flow in that particular city? For instance, I can tell you that hands-down the price-to-rent ratios in Los Angeles are not supportive of cash flow. I can tell you that the price-to-rent ratios in Indianapolis are generally favorable for cash flow. In no way does that mean every property or every location within Indianapolis will cash flow, but it does mean there is an option for it—whereas in Los Angeles, there’s really no option for cash flow.
Now, let’s say a particular market has generally favorable price-to-rent ratios for cash flow.
Oh wait, I just heard you ask—how do I know if a market has favorable price-to-rent ratios? Great question. The fastest way to find that out is to network with other investors. You can either ask other people where they are investing, which I already mentioned, or let’s say you have a family member in a particular city and you’re curious about whether or not you can cash flow there. Post in a BiggerPockets Forum and ask people if they have any knowledge of cash flow potential in said market. Look for people investing there, and find out the best places for cash flow there. If all of that fails, start looking up properties and running those equations I taught you and see if you’re coming out ahead on cash flow.
Let’s say a particular market has generally favorable price-to-rent ratios for cash flow. This is where that second question I asked comes in—how likely am I going to be able to sustain those numbers?
The answer to this question is lengthy, so I’ll just give you one basic thought to consider for now. Is the market you are looking at a growth market or a declining market? The reason this matters is because you can project cash flow numbers until the cows come home, but if certain factors come into play with your property, you may never see a single bit of that projected cash flow materialize. Bad tenants, for example, can cause you to not see a penny of your projected flow because they can cost so much in expenses, IF they are even paying the rent.
For details on growth versus declining markets and how to know what factors you can look at to determine which one your market of interest falls under, check out “How to Know If Any Given Real Estate Market is Wise to Invest in (With Real Life Examples!).”
To help you understand the potential consequences of investing in a declining market, check out “5 Risks of Buying Rental Properties in Declining Markets.”
Step #3: Decide on a Market
Your list of potential markets should be even shorter now than it was when you narrowed it down from 19,354 cities to either cities you know people in or have ties to or cities other investors recommend. Now your list should only include markets/cities that the numbers not only work in but also where the numbers have good potential of sustaining themselves. That last part is purely my own personal investment strategy preference—it’s certainly not a requirement.
You may have one market on your list at this point, or you may have a handful. Which one you ultimately decide on may just come down to personal preference at this point—or it may depend on your situation and your resources.
Some things you can look at now include, but are not limited to:
You just might not have enough capital to invest in all of the good options out there. For instance, I know of some amazing deals in Baltimore and Philadelphia, but those particular deals require a minimum of $90,000 up front. You may not have $90,000. You might only have $20,000. Well, good news—$20,000 can get you a great cash-flowing property in other cities!
So for your budget, you may stay focused on one area over another. I used to work with triplexes in both Chicago and Philadelphia. At that time, you could get a good cash-flowing triplex in Philadelphia for $130,000. The triplexes in Chicago at the time were bigger and nicer, and they were around $270,000. The cash flow on those was higher, of course, but not everyone’s budget would support buying one of those triplexes. But many of those people could get one of the Philadelphia triplexes. So, more than anything, your available capital may further limit you on where you can invest. Not always, but it is a consideration.
This is simply a personal preference factor. For example, some markets like Philadelphia and Baltimore tend to have properties with more of an urban feel, and they are often more of the row house-type of structure. Not everyone likes the urban feel, and not everyone likes adjoined buildings. The other option would be properties with a suburban feel that are free-standing. You can find lots of these in the Midwest. Additionally, some markets offer a lot of multi-family (MFR) options, and some markets only have single-family (SFR) options that will cash flow. So, if you before urban or suburban over another, and if you prefer SFR or MFR over another, those personal preferences will steer you towards particular cities and away from others.
Related: Forget the Demographics and Focus on Researching THIS Before Investing Out-of-Area
Look! You’re continuing to narrow down your list! Here’s a couple more to help you further narrow.
Returns vs. Risk
At the end of the day, some cities and property types will be more risky than others. Even if you are looking within stable growth markets and none of the areas you are looking in are majorly dangerous, some may have significantly better schools than others, etc. Maybe one market is slightly more in a “gentrifying” stage than another, more matured market. It’s always fine to take on a little more risk, but make sure the proposed returns are high enough to justify it. Or if you are more risk-adverse, you may choose to accept slightly lower returns in exchange for staying with a less risky market and property. That’s totally fine as well. So you want to have a feel for the returns versus the risk available to you in each potential market and weigh that against where you are on your own personal scale of desire—what’s more important to you, returns or playing it safer? That should help you further down your list a little bit.
Ease of Commute
This one may be less significant than others, but it could play a role. If you have narrowed your list down to—say, two markets and those two markets are weighted pretty evenly against each other—which one is easier to get to? If a nonstop-not-too-lengthy flight is available to one and to get to the other would require a couple stops and a longer flight time, and probably a more expensive flight, go with the one you can get to easier!
Ultimately, the most important thing about whichever market you decide on is whether or not you will lose sleep over investing there. Maybe it’s because you can’t stomach your investment property being so far out of reach, maybe it’s because the market is a little riskier, maybe you hate single-family homes and really wanted a multifamily. Whatever the situation, go with what will put a smile on your face (and hopefully some cash flow in your pocket).
Just as a quick summary on the steps you can take to help you decide on a market:
Step 1: Narrow down your market options.
- Where do you know people?
- Where are other people investing?
Step 2: Analyze those market options to further narrow down your list.
- Is it a good market to invest in?
- Do the numbers work?
- Will you be able to sustain the numbers?
Step 3: Choose what you like!
- Decide on your personal preferences and see which markets fit those
Then, once you have your market decided on, go shopping! Even if you only narrowed your list down to a couple of cities, that’s fine. Two cities is easier to shop in that 19,354.
And here’s one last tidbit for you. At the very end of it, no matter how or why you chose the market(s) you did, you need to confirm one last thing. Are you ready?
The last thing that matters is that you can form a good team in the market you chose.
If you can’t find good team members to help you with your property, go to another market. If you don’t have a solid team as an out-of-state investor, you’ll be up that famous creek without a paddle.
If you’ve narrowed your list down to a couple of cities you’d be willing to invest in, choose the one that offers the best team. If you’ve narrowed your list down to one city you want to invest in but then you can’t form a solid team of good people there, start over and choose a new market. You must have the team!
There you have it! Now go market shopping.
How do you choose your out-of-area markets for investment?
Leave your questions and comments below!