Is Cash Flow King? Price to Rent and 1% in different OOS markets.

39 Replies

Over the past year, I've been educating myself so as to get my investing start, most like with single family buy and hold. I live in San Diego county, so I've tended to focus on starting OOS. Initially, I was looking closely at a few midwest areas that seemed to easily meet the 1% rule and have low entry price points on sfh's. 

After coming close on a few deals, I stepped back to re-examine my desired focus including what areas to invest. I'm still primarily considering OOS, but am now looking at some areas that have higher entry price points and where a newer investor might be hard pressed to achieve the 1% rule. Partly, I was having a hard time getting as excited about owning long term in some of the markets I first looked at as compared to some I'm looking at now.

Some questions I'd love to hear people chime in on:

 Is cash flow always a primary driving factor? I know there are people actively investing in areas outside the midwest that don't meet the 1% rule, so what is the mindset investing there?

Is having a net zero cash flow acceptable in some areas? I suppose I'm referring to areas that can reasonably be expected to have stable appreciation over the long term and increases to rent. In that case, is having someone else pay your mortgage on a sfh you'll eventually own good enough?

What is the perspective from an investor that might prefer owning one $240,000 dollar sfh vs. three $80,000 sfh's? Does that perspective change significantly if the $80k homes would cash flow out of the gate and the 240k would not?

Any other related thoughts are welcome.

Initial cash flow is more important to new RE investors than more established RE investors. I more look at COC and ROI and occasionally ROE. I could care less where the profit comes from. Cash flow is just one source of RE profits.

We invest in San Diego county. We have historically achieved outstanding ROI. We have purchased an RE that projected, with our conservative estimates, as cash neutral RE. We can justify the purchase. It has produced an outstanding ROI but its cash flow is still not what most of our RE has achieved.

I think you are on the right track realizing that 1% properties may not be as good an investment as properties that are not 1% properties.  You need to evaluate all expected profits but projections should be conservative.  This implies using high cap expense, vacancy, and maintenance estimates and low appreciation (rent and property) estimates.

I would rather manage one property that produce $5K/year than 3 properties that produce $7K/year in total.  RE is not 100% passive.  Less RE implies less work.  if we scale the numbers we would get 10 properties produce $50K/year or 30 properties to produce $70k/year.  I can handle 10 properties but can I handle 30 properties?  Maybe with either office staff or property management I can handle 30 properties.  But at some point a limit is hit.  Would you rather hit that limit with properties producing $5k/year or properties producing $2.7K year?

Originally posted by @Chad Lanting :

Over the past year, I've been educating myself so as to get my investing start, most like with single family buy and hold. I live in San Diego county, so I've tended to focus on starting OOS. Initially, I was looking closely at a few midwest areas that seemed to easily meet the 1% rule and have low entry price points on sfh's. 

After coming close on a few deals, I stepped back to re-examine my desired focus including what areas to invest. I'm still primarily considering OOS, but am now looking at some areas that have higher entry price points and where a newer investor might be hard pressed to achieve the 1% rule. Partly, I was having a hard time getting as excited about owning long term in some of the markets I first looked at as compared to some I'm looking at now.

Some questions I'd love to hear people chime in on:

 Is cash flow always a primary driving factor? I know there are people actively investing in areas outside the midwest that don't meet the 1% rule, so what is the mindset investing there?

Is having a net zero cash flow acceptable in some areas? I suppose I'm referring to areas that can reasonably be expected to have stable appreciation over the long term and increases to rent. In that case, is having someone else pay your mortgage on a sfh you'll eventually own good enough?

What is the perspective from an investor that might prefer owning one $240,000 dollar sfh vs. three $80,000 sfh's? Does that perspective change significantly if the $80k homes would cash flow out of the gate and the 240k would not?

Any other related thoughts are welcome.

I grew up Inc Escondido. Now live downtown. I realize that San Diego doesn’t really cash flow but I assumed Escondido would given it’s not really the best (high demand, sort of BFE) area. 

I always assumed if I wanted to buy in “San Diego” I’d end up buying north county. My parents still live there (Go Patriots!)

Hi Chad,

Cash flow is king and it's very important but I would not be purchasing OOS properties in D to C- areas to try an achieve it.  Chasing yield can backfire on an investor.  There is a slew of negatives when dealing with those type of properties.  I think the biggest is the loss of time. Like @Dan Heuschele mentioned in his post. Do you really want to handle 30 properties?  I would much rather handle 10 and have more time, but that's me.

Ideally investing locally is the best way to go if you can afford it financially.  In your case San Diego.  What an amazing place to invest with historically solid returns.  I understand that it might not be great at the moment because of the run-up.  Be patient,  deals come up all the time. 

Now if you are going OOS.  You can certainly achieve 1% or better and buy in B properties.  Just got to look in the right areas and buy value-add deals. 

@Dan Heuschele , thank you for the input. I know you invest in my area, so I appreciate your take. While I'm not currently looking to invest in San Diego County, I may in the future, and part of my stepping back to re-evaluate my approach included some thoughts as to owning assets that were ultimately worth more, even if they didn't cash flow as well right at the start. I know I've read some of your posts regarding the historical performance of CA vs. other markets, and your insights have been helpful.

@Cody L. , I figure the "Go Patriots" is a reference to Orange Glen? If so, I graduated there as well. As for investing in Escondido, I know @Dan Heuschele has been pretty successful there and with other North County locations. I think it's difficult for a number of reasons for me: First, I'm newer, so I don't have the systems in place in a state where every aspect of the process seems to cost more. Second, the entry price point is pretty high for any properties I'd want to own. I'm not looking to target severely distressed properties for my first investments. That said, I may take a closer look at North County once the market begins to soften.

@Frank Wong , I appreciate the advice. I can recognize that San Diego area has enjoyed long-term impressive returns, and there is a part of me that wonders if I'll invest here eventually. For now, I don't know that I'm positioned to eke out any true deals in this market. I might need to wait for things to soften and then hopefully be poised to acquire a few deals at a future time. I think I'm tending to be considering something like your last statement about trying to target B properties in OOS markets. 

Some possible places I've considered are parts of UT, OR, and TX which I feel are somewhere between what is happening in CA and the midwest. I don't mean geographically, so this may be an oversimplification, but I'm interested in places with steady job and population growth where entry sfh's are in the 150-300 range. These locations don't enjoy the initial cash returns of some midwest markets, but don't have quite such an inflated entry price as San Diego.

Yield, in any asset class, whether real estate, bonds, dividends....is a function of risk.  This is an incredibly important concept that people on the site often ignore.  High yield = high risk. Low yield = low risk.  Now there is nothing wrong with high or low yields, you just have to understand that it is a function that the market uses for pricing in the risk of the underlying asset and/or market. Yield measures risk, yield does not measure return.  It is one, of many components of the return, but it is not the total return of the asset.

Originally posted by @Chad Lanting :

@Frank Wong , I appreciate the advice. I can recognize that San Diego area has enjoyed long-term impressive returns, and there is a part of me that wonders if I'll invest here eventually. For now, I don't know that I'm positioned to eke out any true deals in this market. I might need to wait for things to soften and then hopefully be poised to acquire a few deals at a future time. I think I'm tending to be considering something like your last statement about trying to target B properties in OOS markets. 

Some possible places I've considered are parts of UT, OR, and TX which I feel are somewhere between what is happening in CA and the midwest. I don't mean geographically, so this may be an oversimplification, but I'm interested in places with steady job and population growth where entry sfh's are in the 150-300 range. These locations don't enjoy the initial cash returns of some midwest markets, but don't have quite such an inflated entry price as San Diego.

 

Not that I need more competition (especially seeing you are in my exact top market), but have you considered house-hacking a detached duplex? Note 95% LTV (owner occupied) versus a 75% LTV (OOS investor) implies that via house hack you can purchase a RE in San Diego for 5X the cost of your OOS investment with a similar out of pocket cost.

Cody L invests in Houston and appears to have done quite well but Texas is a higher property tax state (last I read it was the 3rd highest).  It is counter intuitive for an investor from a high income tax state (i.e. CA) to invest in RE in a high property tax state (i.e. TX). OR has perhaps the least friendly LL laws in the US (from what I have read, worse than CA).  I suspect every area possibly has a reason that makes it less than ideal for RE investing.  For example, you believe the reason not to invest local is the high entry price.  I do believe that if I had 2 hours to spare, I could convince you otherwise, but alas I do not have the 2 hours to spare.

Good luck where ever you choose to invest

Originally posted by @Chad Lanting :

@Cody L., I figure the "Go Patriots" is a reference to Orange Glen? If so, I graduated there as well. As for investing in Escondido, I know @Dan Heuschele has been pretty successful there and with other North County locations. I think it's difficult for a number of reasons for me: First, I'm newer, so I don't have the systems in place in a state where every aspect of the process seems to cost more. Second, the entry price point is pretty high for any properties I'd want to own. I'm not looking to target severely distressed properties for my first investments. That said, I may take a closer look at North County once the market begins to soften.

 Yup.  Orange Glen, class of 93.  I'm old  :(

I was suggesting that North County, specifically Escondido, should be okay vlaue for the $ as when most people get sticker shock from "San Diego" they're looking coastal, or actual San Diego and not far out east, or far north where it's not so crazy.

I'm big into investing OOS but I accept it's not for everyone.  You have to make sure you know the submarkets just as good if not better than your home turf.  And you have to have a trusted team.  When I moved back to San Diego from Houston, I had a team managing 500 (?) units of mine and it was still hard until I cycled though the right ops person after 4 tries.  But in the 4 years or so I've been back, having the right team has allowed me to go from 500 to ~1400 units all from SD.

Originally posted by @Russell Brazil :

Yield, in any asset class, whether real estate, bonds, dividends....is a function of risk.  This is an incredibly important concept that people on the site often ignore.  High yield = high risk. Low yield = low risk.  Now there is nothing wrong with high or low yields, you just have to understand that it is a function that the market uses for pricing in the risk of the underlying asset and/or market. Yield measures risk, yield does not measure return.  It is one, of many components of the return, but it is not the total return of the asset.

Very true.  I'd add, though, that it's particularly true for asset classes trading through highly efficient markets.  Real estate - especially the type that individual investors like the OP is targeting - is anything but a highly efficient market.  Trick is to dig up an oversized yield with an undersized risk.  And that's typically done by building an advantage others don't have.

Investors who buy properties in expensive markets like San Francisco, Los Angeles, San Diego, etc. that do not cash flow with standard metrics have other motives. Some are 1031x that need to find an asset quick where they can park their money. REIT's, large funds, etc are chasing yield in stable assets outside of the stocks and bond markets to diversify so they are happy with 4% caps in real estate. International investors #1 focus is not making tons of cash flow from investments but protect their money from government regulations, ie. China. Sometimes it's a tax move.

You need to look at cash PLUS appreciation when looking at investments.  You can buy $80k houses in middle america that cash flow but appreciation is relatively flat.  Or you can buy in expensive cities and bank on appreciation while being cash flow negative.  The excellent deals have both in play to your favor.  Yeah, it's hard to find those deals...that just means you have to network and search harder.

Originally posted by @Russell Brazil :

Yield, in any asset class, whether real estate, bonds, dividends....is a function of risk.  This is an incredibly important concept that people on the site often ignore.  High yield = high risk. Low yield = low risk.  Now there is nothing wrong with high or low yields, you just have to understand that it is a function that the market uses for pricing in the risk of the underlying asset and/or market. Yield measures risk, yield does not measure return.  It is one, of many components of the return, but it is not the total return of the asset.

You're 100% right re: risk/reward.  But those rates, like stock prices, are set by the overall market consisting of millions of customers all with access to the same information.  And they're not always 'right' (I'm just not smart enough to outsmart the stock market but in some small submarkets of RE I think I can see errors).

Some stock is still smart to buy because the overall market has assumed wrong regarding it's value (with the inverse just as true).  I also feel in some areas of RE, the market has been too hard on, making cap rates higher than I feel they should (with the inverse just as true).

My whole business model is trying to find those properties that are priced lower than they should be due to the overall investor sentiment being more negative than my own outlook.  They might view a property as risky, and punish it via a low price below where I feel it should be. 

Classic example is this property I bought downtown (I hate to keep using that one as an example, it's just that one was on loopnet for a long time so no one can say 'well you just got a good off market deal').  That one people worried about due to it's occupancy and current condition -- both easily fixed.  And it's downtown across from the Toyota Center for crying out loud.   As such, I was able to buy it, fix it, and have it appraise for way over my buy+rehab price and get all + my $ out.  In just a few months.

If I wasn't able to find properties that I feel the market had given the wrong risk/reward to, I'd have no way continue to buy new properties (at least not without bringing in new outside funds which I've not wanted to do).  So I need to keep making the right call, so I can keep getting the equity from a property to get the next.

Originally posted by @Justin R. :
Originally posted by @Russell Brazil:

Yield, in any asset class, whether real estate, bonds, dividends....is a function of risk.  This is an incredibly important concept that people on the site often ignore.  High yield = high risk. Low yield = low risk.  Now there is nothing wrong with high or low yields, you just have to understand that it is a function that the market uses for pricing in the risk of the underlying asset and/or market. Yield measures risk, yield does not measure return.  It is one, of many components of the return, but it is not the total return of the asset.

Very true.  I'd add, though, that it's particularly true for asset classes trading through highly efficient markets.  Real estate - especially the type that individual investors like the OP is targeting - is anything but a highly efficient market.  Trick is to dig up an oversized yield with an undersized risk.  And that's typically done by building an advantage others don't have.

 I wouldn't have given my long rambling reply if I read yours.  You said what I said much more concisely.  Have an upvote!  :)

@Cody L. , I graduated in 99, so not too far off. I think it's likely that there are better deals in Escondido than most neighborhoods in San Diego proper. I think there is something about OOS investing that almost appeals to me more than local. It could be that I enjoy researching new areas and perhaps it's a way to experience areas vicariously. That said, I absolutely appreciate your thoughts on thoroughly understanding the market and having a trusted team in place.

@Paul Choi , I like your input on looking at both cash flow and potential appreciation and the idea of looking for deals that have both elements coming into play.

Dan Heuschele, I'm not inherently against investing locally, and for now, as a new investor, I'm not sure I represent your competition. I hadn't yet considered thinking of income tax and property tax being in some way inversely related in states, but I track your point on not taking highly income-taxed dollars into highly property-taxed states. 

@Chad Lanting

Nice thread.

I have always focussed on cash flow, its not always been the easiest ride, but I believe if I could find a solution to a problem I could make a market work. 

I started in the Atlanta market in 2011, buying foreclosure properties, rehabbing and renting, these well and truly met the 1% rule, today would be a different story. 

At the time I was told by many investors I was buying the wrong properties as they were C grade. The rest is history, as Atlanta has experienced massive appreciation in practically all neighbourhoods. 

My focus is still cash flow, lower end in Detroit, but  I certainly not buying in war zones. I am following the same principals, buy in low, good neighbourhoods that are gentrifying that will cash flow and increase my income stream.  Slow and steady she goes... but its working for me.

@Bala Apparao , thanks for the feedback and your thoughts looking back on your journey and process. As I read more and engage in these threads, I'm realizing that maybe my focus won't be cash flow centered to start. 

I read many threads where OOS investors are freaking out because x,y, or z went wrong and the whole thing is blowing up.  I find it pretty sad that so many folks are led astray. 

I would invest close to me. Where I can either self manage, or keep my eye on things.  This also allows me to know the market and not have to rely 100% on others for everything. 

I had CA money (sold a nice commercial bldg in SOMA in SF) and went hunting - I spent 6 months driving around. I was advised by a very smart person to find MF in a college town. This is what I did. I moved (i know not possible for some) to Oregon and am very happy with the 10 unit bldg i bought. Its about a 7cap for me. :) 

So long story short - keep your assets close to you  do not let others control your money   

And finally - once you take your $$ out of CA you will have a hard time coming back as RE will appreciate in CA but your asset elsewhere wont be able to keep up most likely  

@Chad Lanting . I would advise against buying property in Texas. You get to pay high property taxes there and high income tax in CA. Uncle Sam will thank you as you pay lots of taxes.

@Mary Mitchell , I value your story. It sounds like you had a successful transition to a great MF opportunity combined with a new home base to live.

@Caleb Heimsoth , thanks for the thought. @Dan Heuschele had something similar to say about not taking heavily income taxed $'s into heavily property taxed states.

Chad, 

Cashflow is just one aspect of the over-all profit of the deal. 

"A" areas tend to have little to no cashflow but great appreciation

"B" areas tend to have more cashflow and some appreciation

"C" areas tend to have very good cashflow and little appreciation

"D" areas tend to have a lot of cashflow with headaches and NO appreciation

"F" areas (warzones) have mind boggling cashflow, mind boggling headaches/hassles and negative appreciation by the time you factor in inflation

Investing OOS is risky when you chase that 1% rule buying in "C" areas which are really "D"s or "F"s. 

Personally, I like to force the appreciation through quickly solving the problems of the property and/or doing value add improvements. MF investing is better in this regard than SF (I've done both). 

Here's an example:

https://www.biggerpockets.com/forums/311/topics/64...

@Chad Lanting - If I were to buy my own home again, I would buy either a duplex or at least a single-family home with an in-law unit. I own 3 single-family homes in San Francisco. I would rather manage one expensive home than 3 inexpensive homes because it's a lot less work. The two homes that I rented out to tenants were initially cash-flow-neutral or negative. They needed significant cosmetic work, and by spending $30K-$100K on each I gained twice that in value. The appreciation--from rehab and the Bay Area market--has been great, which was my main goal. And the rents have increased every year, so that in 5 years the cash flow has become solid and in 5 more years it will be strong. The downside in an expensive market like the Bay Area or New York is that often the cash flow isn't there. To balance the great long-term investment with cash flow, I've built a business renting homes from other landlords, then doing cosmetic repairs and renting them out to business travelers. It's been a nice balance so I can gain cash flow without needing to sell a property or refinance out of a low-interest mortgage.

Good luck to you!

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