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Updated about 8 hours ago on . Most recent reply
Out of state investing
Hey! So i have a 2 part question. First time investor in real estate and i wanted to get insight in buying property out of state and renting long term. Is this a good idea. Second, I have 60k in home equity that i want to use, what type of loans would be best to use my home equity? Thanks in advance
Most Popular Reply
Hi Victor,
The proposition of buying property out of state comes with some associated "givens". If you buy out of state, you are necessarily going to be using property management. You might say, "Why yes, that was the plan!" But there is a counter balance to doing that - and that is the expense of it.
The best way I can explain it would be to give you a fast example. Let's say you make $300/month free and clear after principal, interest, taxes, property insurance, and a maintenance reserve each month on a financed out of state rental. So your expected "net" income is $3,600/year if you were self managing a property locally).
Now let's put that property a state away, and bring in the property manager. Let's say your rent is $1,200/month. The average property manager is going to take 10% gross each month, and when there is a turn-over, they usually charge the first month's rent to place a tenant. (We'll neglect the vacancy rate of 2-4 weeks that probably comes along with that as well just to not make the example too extreme.)
So the property manager is going to take $120/month for his monthly fee, and $1,200 for filling the unit. Of the potential $3,600 you thought you were going to make that year, the property manager just took $2,640. That would be 73.3% of your potential net profit for the year. And this scenario presumes you didn't have any significant repair costs to cover as well. There are obviously a lot of other benefits to owning an investment property besides cash flow... but it is the cash flow that allows you to hold onto the property as you gain appreciation, and mortgage pay down, and take advantage of tax write-offs. Some would argue that low cash flow is acceptable. I would agree you will always make more off of appreciation... but for myself, I actually live off the cash-flow of our portfolio... so it isn't acceptable for me personally -and I don't think it is smart from an investment perspective because it puts you more at risk. So... food for thought there.
I would personally suggest trying to buy something local if it makes sense and avoid those fees. You gain a lot of experience along the way as well which will make you a smarter RE investor down the line. Honestly it is really quite easy. One of the biggest secrets is to subscribe to a cloud-based property management platform. We use one called Rentec-Direct - but there are dozens of them other there. They will collect your rent, screen your tenants, broadcast your rentals, track your expenses, and so on. They are very affordable and make life a lot easier.
Keep in mind that borrowing money (Home equity loan) to borrow more money (mortgage) creates 2 expenses you have to overcome each month. You will have a higher payment each month to try and cover if going that way.
Be sure to consider what happens if a tenant quits paying rent, and then doesn't move out and you have to evict them - from a state away... (read attorney fees, filing fees, a month or two of lost rent as well where you have to pay the mortgage, plus the Home Equity loan out of your own pocket). It's not that it happens all the time... but it does happen. You need to make sure you are financially stable enough to absorb those types of things, plus if anything big breaks... like a $5,000 AC bill, or needing to replace a roof, etc.
It's not that I'm trying to paint a bleak picture... I just don't like to see a beginner think it's all going to be blue sky and butterflies and then run into what should be somewhat expected complications. We had a bad run on air conditioners last summer and had to replace 7 units in 2 months! That was $30-35,000 in maintenance we had to cover. Just starting out that won't be you - but $5,000 just starting out is big enough!
As you build a portfolio the nice thing is that the other units kick in to help cover / offset high expenses another unit might run into. But just starting out where you just have one or two is probably the most dangerous time as far as finances go if you aren't deep on cash. So I offer those cautions to you.
We do long term rentals. They are fairly stable, but will net less money than short term rentals as a whole. Out of 37 units we self-manage, we probably turn over 2-3 a year.
Otherwise, as far as loans go - I would say that very little cash flows well when financed at 7% interest rates. Too much of your money is going to the bank in the form of interest. With the high rates we are at right now, I would probably suggest a shorter term adjustable rate mortgage with the intent to refinance it down the line (presuming you think mortgage rates will eventually fall back down).
You have to find really good deals where you can net a descent cash flow to make it make sense to buy something. Don't buy something because it cash flows $100/month. Your money is way better off sitting in the bank earning 4% interest in a savings account in my opinion. It's just not worth the hassle of tenants and risk of potential expenses if you ask me. For us, our line in the sand on a financed property is that it has to make at least $300/month/door. So a duplex would be $600/month after principal, interest, taxes, insurance, and a maintenance reserve. As you do own properties longer, you do benefit from rent increases to help you make some more money, and there is always the option of refinancing higher interest mortgages down to lower ones at some point.
Hope some of it helps!
Randy