Seeking Advice for a Beginner in a HCOL Area

[Evan Shults]

Hi all!

I've been a long time lurker, first time poster here! Thanks in advance for any feed back you are willing to offer!

Background

• Age: 35
• Industry: Aerospace Engineering (W-2 income: $140k/yr)
• Household:
  • Spouse (34), part-time nurse, stay-at-home mom
  • Two children (4 years, 6 months)
• Location: High Cost of Living (South Bay, CA)
• Available Time: ~10–15 hours/week
• Funds Available to invest: ~50k

Objectives

Primary Goal:

• Achieve W-2 income independence within ~15 years.

• Generate sufficient cash flow in the near term to allow my wife to be work optional. Ideally <2years

Constraints & Assumptions

• Geographic constraint:
  • South Bay HCOL pricing limits feasibility of local house hacking or multifamily purchases.
• Experience constraint:
  • First investment property.
  • Common advice suggests avoiding out-of-state (OOS) investing initially.
• Cashflow constraint:
  • Current w2 works now but children wont become cheaper
• Time constraint:
  • Part-time involvement only (10–15 hrs/week)

Problem Statement

Given:

• High local acquisition costs
• Warnings against OOS investing for a first deal,
• A near-term need for cash flow

What investment strategy best satisfies the 2-year cash-flow goal while aligning with the 15-year independence goal?

Options Under Consideration

Option A: Local House Hacking / Multifamily

• Status: Though most interesting, likely infeasible due to South Bay pricing.

Option B: Out-of-State Long-Term Rentals

• Potential Benefits
  • Markets better positioned to align with long term goals
  • I have lived in several areas where I could potentially go for (Alpharetta, GA, Pensacola, FL, New Orleans, LA, Denver/Boulder,CO)
• Concerns:
  • Higher execution risk for a first investment.

Option C: Short-Term Rentals (STRs)

• Possible Target Markets within 3hrs of home:

1. Big Bear
2. Joshua Tree
3. Palm Springs

• Potential Benefits:
  • Higher cash flow potential
    • Could satisfy 2-year income requirement
  • Possible secondary use as a family vacation property
• Concerns:
  • Risk, regulation, volatility, and scalability relative to long-term goals
  • Time commitment

Open Questions for Feedback

• Is STR a reasonable first investment given the constraints?
• Are there alternative strategies that better balance risk, cash flow, and time?
• How should I weigh short-term cash flow vs. long-term scalability at this stage?
• Looking for good meetups in the South Bay area

[Michael Smythe]

Quote from @Evan Shults:

Hi all!

I've been a long time lurker, first time poster here! Thanks in advance for any feed back you are willing to offer!

Background

• Age: 35
• Industry: Aerospace Engineering (W-2 income: $140k/yr)
• Household:
  • Spouse (34), part-time nurse, stay-at-home mom
  • Two children (4 years, 6 months)
• Location: High Cost of Living (South Bay, CA)
• Available Time: ~10–15 hours/week
• Funds Available to invest: ~50k

Objectives

Primary Goal:

• Achieve W-2 income independence within ~15 years.

• Generate sufficient cash flow in the near term to allow my wife to be work optional. Ideally <2years

Constraints & Assumptions

• Geographic constraint:
  • South Bay HCOL pricing limits feasibility of local house hacking or multifamily purchases.
• Experience constraint:
  • First investment property.
  • Common advice suggests avoiding out-of-state (OOS) investing initially.
• Cashflow constraint:
  • Current w2 works now but children wont become cheaper
• Time constraint:
  • Part-time involvement only (10–15 hrs/week)

Problem Statement

Given:

• High local acquisition costs
• Warnings against OOS investing for a first deal,
• A near-term need for cash flow

What investment strategy best satisfies the 2-year cash-flow goal while aligning with the 15-year independence goal?

Options Under Consideration

Option A: Local House Hacking / Multifamily

• Status: Though most interesting, likely infeasible due to South Bay pricing.

Option B: Out-of-State Long-Term Rentals

• Potential Benefits
  • Markets better positioned to align with long term goals
  • I have lived in several areas where I could potentially go for (Alpharetta, GA, Pensacola, FL, New Orleans, LA, Denver/Boulder,CO)
• Concerns:
  • Higher execution risk for a first investment.

Option C: Short-Term Rentals (STRs)

• Possible Target Markets within 3hrs of home:

1. Big Bear
2. Joshua Tree
3. Palm Springs

• Potential Benefits:
  • Higher cash flow potential
    • Could satisfy 2-year income requirement
  • Possible secondary use as a family vacation property
• Concerns:
  • Risk, regulation, volatility, and scalability relative to long-term goals
  • Time commitment

Open Questions for Feedback

• Is STR a reasonable first investment given the constraints?
• Are there alternative strategies that better balance risk, cash flow, and time?
• How should I weigh short-term cash flow vs. long-term scalability at this stage?
• Looking for good meetups in the South Bay area

You’re ALWAYS better off investing locally, where it’s easier to:

• Learn the market
• Network to find deals
• Network to find contractors
• Be more hands-on
• Driveby property to keep tabs on it
• Network to find a decent Property Management Company (PMC)

Next best location is somewhere else you lived, where you have an existing network of family & friends to help you as accomplish the above list as needed.

If you invest OOS, your biggest challenge won't be finding properties to meet your goals on paper, it’ll be successfully outsourcing all of the above.

The biggest mistake we see OOS investors making in our market, over and over again, is not fully understanding Neighborhood/Property/Tenant Classes and how they impact your probability of success!

They all run their ROI numbers assuming Class A results – when buying Class B, C & even D rentals.

Then they’re shocked when their performance expectations aren't met😞

If you choose to invest OOS, and have little to no landlord experience, we highly recommend targeting Class B Neighborhoods/Properties/Tenants. If you target Class C, you better be prepared emotionally & financially for plenty of challenges.

You can find Class B properties in the Midwest to BRRRR, but it will take more digging and YOU will need to understand how to analyze & identify them - because a lot of agents, wholesalers, PMCs, etc. will try to sell you Class C or D misrepresented as Class B:

• Many of them don't know/care what Class the properties are, so they're incompetent.
• Others know exactly what they are doing, so should be labeled as crooks!
  EITHER WAY YOU LOSE!

Here's some copy & paste advice you might find useful:

Why is Property Class so important for investors to understand and apply in their investing strategies?

Because the Property Class dictates the Class of the tenant pool that the property will attract.

The Tenant Class greatly impacts rental income stability and property maintenance/damage by tenants.

Both Property Class and Tenant Class will affect what type of contractors, handymen and property management companies you should target and be willing to deal with a property.

The Property Class will also impact the maintenance & renovations you do to, “Maintain to the Neighborhood”.

Why is that important?

Well, if you buy & renovate a property in Class D area to Class A standards, what Tenant Class will actually rent it?

Or, if you put several Class D tenants in a Class A four-plex, what do you think will happen to the property?

So, if you fail to apply the correct assumptions to a property, your expectations won’t be met, and it may even be a financial disaster.

We use the following to rank Property Classes, in order of importance:

• Property Tenant Pool: closely linked to location, but not always.
• Property Location: closely linked to tenant pool, but not always.
• Property Condition & Amenities: it’s important to, “Maintain to the Neighborhood.”

Key metrics for each Property Class:

Class A Properties:
Tenant Pool: Majority of FICO scores 680+, no convictions/evictions in last 7 years.
Tenant Default: 0-5% probability of eviction or early lease termination.
Section 8: Class A rents are too high and won’t be approved.
Vacancies: 5-10%, depending on market conditions.
Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.

Class B Properties:
Tenant Pool: Majority of FICO scores 620-680, some blemishes, no convictions/evictions in last 5 years.
Tenant Default: 5-10% probability of eviction or early lease termination.
Vacancies: 10-15%, depending on market conditions.
Cashflow vs Appreciation: Typically, 1-3 years for positive cashflow, balanced amounts of relative rent & value appreciation.
Section 8: Class B rents are usually too high for the Section 8 program.

Class C Properties:
Tenant Pool: Majority of FICO scores 560-620, many blemishes, but should have no convictions/evictions in last 3 years. Verifying recent 2-years of rental history very important! Same for 2-years of job/income stability.
Tenant Default: 10-20% probability of eviction or early lease termination.
Section 8: Class C rents usually meet program requirements, proper screening still recommended.
Vacancies: 10-20%, depending on market conditions and tenant screening.
Cashflow vs Appreciation: Should cashflow immediately, at the lower end of relative rent & value appreciation.

Class D Properties:
Tenant Pool: Majority of FICO scores under 560, little to no good tradelines, lots of collections & chargeoffs, but should have no convictions/evictions in last 12 months. Verifying last 2-years of rental history and income/employment extremely important to find the “best of the worst”.
Tenant Default: 20-30% probability of eviction or early lease termination.
Section 8: Class D rents meet program requirements, often challenges to pass Section 8 inspection.
Vacancies: 20%+, depending on market conditions and tenant screening.
Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation.

Where did we get our FICO credit score information from?

Check out this chart:

FICO Score	Pct of Population	Default Probability
800 or more	13.00%	1.00%
750-799	27.00%	1.00%
700-749	18.00%	4.40%
650-699	15.00%	8.90%
600-649	12.00%	15.80%
550-599	8.00%	22.50%
500-549	5.00%	28.40%
Less than 499	2.00%	41.00%

Source: Fair Isaac Company

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.

Metro Detroit has 132 cities, the City of Detroit 183 Neighborhoods, which we’re analyzing and classifying. Check out the map on our website where we’ve made this all easy to follow.

We can also share numerous examples of properties & portfolios we’ve assisted investors with!

DM us if you’d like to discuss this logical approach in greater detail!

Horror Stories from those that did NOT Understand What they were Buying:

https://www.biggerpockets.com/forums/48/topics/1137397-baltimore-a-path-to-never-ending-pain

https://www.biggerpockets.com/forums/432/topics/1231840-sell-at-a-loss-or-rent-at-a-loss

https://www.biggerpockets.com/forums/311/topics/840134-memphis-turnkey-tenant-turnover-costs

https://www.biggerpockets.com/forums/963/topics/1195280-experience-of-oos-investing-in-cleveland-after-15-years