As an Out-Of-State Investor for 9 Years…

[Jenning Y.]

Happy New Year!

I am from Houston Metro and have been investing in out of state (OOS, or remote) for about 9 years. I own rental properties in five US states (UT, ID, CA, FL, TX). I started investing in 2012 and invested total of about $100k of my own cash (about $40k in 2012, and $60k in 2013). So far for every $1 of own cash invested, I got about $12 appreciation, and $2 loan paydown, but with about zero cash flow (the poor cash flow is partly due to my continuous cash out refinancing and reinvested the proceeds).

I am somewhat a passive investor, super lazy and introvert. All properties were bought on market prices, most with no value added, no any creative financing (all with 20~25% down with fixed conventional loans), no other partners except my wife. For most properties I have never seen them personally (including some been sold already), never seen a tenant. I do not want to manage properties even if they are my next door neighbors.

My strategy is very simple: buy and hold, cash out, then buy again with the cash out.

I first bought two distressed properties in California Central Valley in 2012. Then during 2013~2014 I bought several others in a small bubble coastal city of central Florida. After 2017, I started investing in high growth Mountain states, mainly fourplexes. About three fourth of my assets were acquired after 2017, using the appreciation cash out of previously bought properties.

Whenever I needed to make a choice between appreciation potential and cash flow, I would go with appreciation, as long as the cash flow can break even.

Summarizing my strategy will be: seeking above national average appreciation and loan paydown, at least break even cash flow at start then grow cash flow, hold enough cash reserve, and hold long, let time and inflation lift the boat….

Here are some takeaways based on my own experiences.

1. OOS/Turnkey’s Cash Flow Trap

To me as an OOS investor, the cash flow is pretty much like the carrot in front of a donkey – He can only watch the carrot but will never grab it. Unfortunately I found I am just that donkey and am falling into the cash flow trap. As much as I so love cash flow, in reality I never really got it. I think there are two reasons:

• PM fees eat up the cash flow. 10% PM fees are very common, some also charge up to one month's commission (about 8.3% rent if with 1% rule) for tenant placements. So the PM fees are about 10%~18.3% of gross rents. If we use 50% rule, means the PM fees are about 20~36% of NOI. If removing mortgage interest cost and capital paydown from the NOI, the PM fees will be even larger percentages of net profit and cash flow.
• Higher repair costs by third parties. If managing properties by ourselves, we can cut some expenses, especially for some small repairs such as toilet leaking, changing AC capacitors etc. But if repaired by third parties, we should expect higher repair costs.

So the idea of buying OOS/Turnkey for cash flow really sucks, because the logic contradicts itself. You want cash flow but do not want an active job – I got that. But:

Cash flow = Active Job

If you do not want to do the active job and want somebody else (PM or turnkey company) to do it for you, the cash flow will be gone with the active job – that’s simple.

I also found cash flow is very hard to predict. I have a rental property in a small town in central Florida. I bought it for about $100K in 2014. In the 6 years since I bought it, my net profit is null(of course negative cash flow): first replaced a new AC, then tenant did not report a leaking in bathroom which caused molds and other big problems, finally the tenant trashed the property when they left. I realized cash flow is probably even harder to be predicted than appreciation. But fortunately the property’s price is almost doubled – turns out not that bad for me.

My take on OOS investing is to be successful, appreciation must be put in higher priority. So that even if we get zero net profit (of course negative cash flow) like the property we mentioned above (It was not my intention to get zero net profit and negative cash flow), at least we can still get something.

2.Avoid High Property Tax Areas

High property tax is the killer of cash flow and appreciation.

Two of my own experiences:

• About 4~5 years ago, I had an opportunity to choose a similar 4-plex property from two states, one in Texas with property tax rate about 3%, another from a Mountain state with property tax rate less than 0.7%. Cap rate and prices are pretty same, and both states with strong population and income growths. It took me less than 30 seconds to make the decision to go with out-of-state. Of course, the result should not be a surprise. Less than 4 years later, my OOS one is appreciated about 50%, with strong cash flow. The Texas one barely appreciated and with poor cash flow.
• I have several rental properties in a small coastal town in central Florida, property tax rate about 1.9~2.4%, in the coming six years since I bought them, the NOIs(also cash flow) were becoming worse and worse. The funny thing is that the rents increased pretty fast, but property tax increased even higher.

With time going, some properties’ cash flows will certainly be getting better and better; this is especially true for states with low property tax such as Colorado or Utah; or state with property tax cap such as California. That’s not always true for some high property tax states like Texas.

3. Some Comments on the Turnkey Industry

I have never bought properties from traditional turnkey providers, though I did buy some new-built properties from a builder. They have in-house management company so we can say these properties are also turnkeys. My comments are for traditional turnkey providers.

I am sure there are some good turnkey providers. And I understand there’s a reason for anything to exist. But I generally have negative views toward the turnkey providers. I even think the whole industry in somewhat is misleading the general public. I think that turnkey probably is the worst business model for investors, though a brilliant and super profitable business model for providers. The reason why it is bad is because most turnkeys focus too much on cash flow, while the PM fees eat up almost all cash flow. The cash flow are just carrots. Some providers are intentionally ignoring the real wealth creator – appreciations. I have to say that is really puzzling me.

Most investors should fare much better if they just buy move-in ready or even new properties in a decent neighborhood in a growing market, and then hold them long. That’s just what I am doing now.

Add a small note, what I have talked about only applies to small landlords with a few 1~4 unit properties. This does not apply to owners with large apartment buildings or large owners with their own in-house team remotely. For example, high property tax is a huge problem for 1~4 unit properties while not a problem at all for large apartment building because it will be absorbed into the expenses.

Lastly, I recall one interesting personal experience mentioned by author Lance Edwards in his book ”How to make big money in small apartments”. Lance Edwards is a fellow Houstonian, like myself. In his first direct mail marking (a time around 2001~2003, he did not mentioned the exact time) he sent out post cards to 50 OOS investors who were living in Hawaii while owned rental properties in Houston. He got 15 responses (he met them personally during his vacation in Hawaii) and bought 23 properties from them, with seller refinancing. The high percentage really puzzled me. Time around 2001~2003 was not a bad time for Houston housing market. In fact, 80s was bad for Houston housing market. But from 90s, Houston’ housing market were appreciating, though probably not at a fast pace. Why so many OOS investors wanted to get rid of their properties? The just wanted to capture the gains, or were just purely burnout landlords?

In the past decade, almost all markets across US have experienced high appreciations. Consequently most landlords should be happy landlords, just like myself, no matter invest locally or remotely. But if the market returns to history normal, will we still be happy with our returns? Will there be lots of burnout landlords again? Especially for OOS/Turnkey investors? I have to admit that if not because I am sitting on high appreciation gains, I would already be a burnout landlord if base on cash flow only. Will I be a burnout landlord one day? We will see…

Thank for reading.

Again, Happy New Year!