All Forum Posts by: Eric Fernwood

Hello Dennis,

We are in Las Vegas and below are performance charts for the property segment we target.

YoY rent growth: 18%!

Three to four months is normal at this time of year. We are currently at about 0.6 months.

YoY appreciation: 28%!

6 months supply is considered a balanced market. We are at 0.6 months.

What is driving housing demand in Las Vegas?

• Jobs - Everywhere you look in Las Vegas there are help wanted signs. The shortage of labor is driving up income and attracting people from other states. Currently we have $22B in new projects under development with another $7B announced. The large number of good paying jobs and the relatively low cost of living is attracting a lot of people to Las Vegas.
• Limited Supply of Buildable Land - Las Vegas is an island surrounded by federal land. At the end of 2019, the amount of vacant buildable land in the Las Vegas Valley was less than 28,000 acres, of which 5,000 to 7,000 acres is not viable for residential development. (87.5% of Clark County is federally owned. 85% of the entire state is federally owned.) Consumption rate is about 5,000 acres/year. See the animated GIF below. The areas in brown are federal land. The time-lapse only goes through 2018 and there was a large amount of development in 2019 and 2020. The shortage of land combined with the increasing population almost guarantees property prices and rent will continue to increase.

• California - California's government seems committed to driving people and companies out the state. Las Vegas continues to receive a part of this exodus. Las Vegas is very attractive to people and companies because of the following:
  • Pro-business government
  • Low property taxes - The average property tax rate is 0.55%. According to MortgageCalculator.org, Nevada has the 9th lowest property tax rate in the nation.
  • Low cost insurance - The cost of property insurance is a good indicator of the risk of a major natural disaster. Nevada has the 10th lowest average insurance cost in the nation.

I can provide more specifics, but I believe the above should give you an idea as to what is happening in the Las Vegas investment market. There are other factors that make Las Vegas attractive to investors:

• Landlord friendly - Time and cost to evict a nonperforming tenant: less than 30 days and $500. Also, the laws allow lease agreements to place much of the cost for damages on the tenant. Plus, the ability to deduct any damage beyond reasonable wear and tear from the tenant's security deposit. The lease agreement terms are the major reason why our target properties' average tenant turn cost is under $500.
• Low property taxes - The average property tax rate is 0.55%. According to MortgageCalculator.org, Nevada has the 9th lowest property tax rate in the nation.
• Low cost insurance - The cost of property insurance is a good indicator of the risk of a major natural disaster. Nevada has the 10th lowest average insurance cost in the nation.
• No state income tax - Pro business government and low cost of operations.
• Low maintenance cost - Las Vegas properties have low maintenance costs due to the construction materials required by the Mojave Desert climate.

In summary, Las Vegas is performing well and likely to do so well into the foreseeable future.

You asked about property management, renovation, and maintenance. We have an investment team and provide all the services you mentioned and more.

Ping me if you have questions.

The type of property you buy is not important. What matters is selecting properties that best enable you to meet your goals. Below is the process I would follow to grow a reliable, inflation advantaged, long-term income stream.

Location Selection

Location is the most important decision you will make, not the property. As long as you buy in a good location, all but the worst mistakes will be corrected over time through rent increases and appreciation. However, if you don't invest in a good location, you can do little to turn things around. So, you have to make the right location decision.

Fortunately, there are a few indicators that make selecting a good location easier than you might imagine. The most important of them all is the rate of appreciation.

• Appreciation - The number one criteria in location selection is appreciation. Inflation is constantly eroding buying power; each year, it costs more to buy the same set of goods. If you buy in a location where prices and rents are rising faster than the inflation rate, you will be able to buy the same set of goods because you will have the additional dollars you need from increased rents. If you buy in a location where prices and rents are increasing below the inflation rate, your only option will be to decrease your standard of living over time. If you are interested, I can post an article showing why appreciation is the fastest way to grow your portfolio and cash flow.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right, including jobs and the cost of doing business. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.

Investment Team

If you needed surgery, you would not start medical school. Also, not just any doctor will do. You want a surgeon that specializes in the kind of surgery you need, not a general surgeon. The same is true with real estate investing. You want to work with an investment team that already has the skills. The place to start is with an investment Realtor. Know that even in a large metro area, there is likely only one or at most two investment Realtors. So, an investment Realtor will likely be hard to find. Below are the skills an investment Realtor provides directly and indirectly through team members. While finding an investment Realtor may take time, the cost, risk, and time savings will be worth it.

Tenant Pool

The only way to consistently make money is to keep the property occupied by what I call a good tenant. A good tenant is someone who:

• Has stable employment in a market segment that is very likely to be stable or improve over time
• Has a credit history with which you can evaluate the likelihood that they will perform
• Pays all the rent on schedule
• Takes care of the property
• Does not cause problems with neighbors
• Does not engage in illegal activities while on the property
• Stays for many years

Good tenants are the exception, not the norm. Good tenants are the result of:

• Targeting the right tenant pool
• Selecting property properties that attract your target tenant pool
• A skilled property manager

How do you determine the right tenant pool that will support your financial goals? Your investment team is your first stop. In addition, I would interview multiple property managers. I believe that the best tenant pool will be obvious once you go through the interviewing process.

Properties

Your investment team will help you to define the property characteristics that will attract your target tenant pool. They should also provide the analytics you will need to make an informed decision, not MLS sheets. MLS sheets have little value to an investor.

In Conclusion

If you follow the location > investment team > tenant pool > property path, you will be on the right track and should do well.

The type of property you buy is not important. What matters is selecting properties that best enable you to meet your goals. For rent rest of this post, I will assume your goal is to augment your current income or to replace your current income over time. In either case, you are looking at long-term performance, not initial ROI.

If this is the case, select properties that best meet the following:

• Appreciation - Prices and rents are increasing faster than the inflation rate. If not, your buying power is guaranteed to decline over time due to inflation. Evaluate appreciation based on the 10 years preceding COVID; the high COVID appreciation rates are likely to be short-lived in most locations.
• Targets the right tenant pool segment - Every property attracts a fairly narrow segment of the total tenant pool population. Determine which tenant pool segment has the highest concentration of "good" tenants and only buy properties that will attract this segment. I define a good tenant as someone who:
  • Has stable employment in a market segment that is very likely to be stable or improve over time.
  • Does not engage in illegal activities while on the property
  • Does not cause problems with neighbors
  • Pays all the rent on schedule
  • Takes care of the property
  • Stays for many years
• Low vacancy costs - Vacancy costs can turn what appears to be a profitable property into a money pit. Vacancy cost is a function of the tenant pool, carrying costs, time to rent, property manager skill, construction and renovation materials, lease agreement terms, and local regulations governing tenants. For example, below are typical annual vacancy cost estimates for the three major Las Vegas tenant pool segments
  • Transient: $3,200/Yr
  • Permanent: $400/Yr
  • Transitional: $3,500/Yr
• Low maintenance cost - The only way to keep maintenance costs low is to not buy properties that need a lot of maintenance. Maintenance cost is a function of property condition, age, climate, construction and renovation materials, tenant pool, and property manager skill.

If you base your property selection on the above, you will make the best decisions. Do not make selections based on dogma or what others say. You are the person who will live with your decision for many years.

Turnkey is a purchase method, nothing more. Buying turnkey does not reduce your due diligence effort. The most important decision you will make is the location. Buy where you can make money today and into the foreseeable future. That means selecting a location that meets all the following criteria.

• Appreciation - The number one location selection criteria is appreciation. Inflation constantly erodes buying power; each year, it costs more to buy the same set of goods. If you buy in a location where pre-COVID prices and rents increased faster than the current inflation rate, you will continue to have the funds you need. If not, the initial cash flow will be the highest you will ever receive, and you will have a continuously declining standard of living.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

Once you've selected a location, you next need to decide which tenant pool to target. Length of tenant stay, maintenance, vacancy cost, and many other things vary greatly by tenant pool. For example, below is the vacancy cost estimate for the three primary tenant pools in Las Vegas. As you can see, there is a huge vacancy cost difference that can only be offset with a much higher cash flow.

• Tenant pool 1: $3,200/Yr
• Tenant pool 2: $400/Yr
• Tenant pool 3: $3,500/Yr

Once you select a tenant pool to target, you then know what type of properties to buy, and you are ready to evaluate which purchase method is best for you. Note, only if the turnkey supplies properties that match your target tenant pool does buying turnkey make sense.

Decision Process

As an engineer, I believe in processes, not feelings and guesses. So, I put together the following decision tree to help you decide which purchase method was best for acquiring a long-term profitable investment.

Other Considerations

In general, turnkey properties will always be more expensive than a direct purchase, which results in a lower return. Turnkey providers must charge enough to cover renovation costs, carrying costs, marketing expenses, tenant acquisition, and profit. These costs are in addition to the actual property acquisition cost. Below is a diagram illustrating the cost difference between direct vs. turnkey. The difference between a direct purchase and buying turnkey is what I call the "convenience fee."

Note that even though you pay more with turnkey and have a lower return, you save some time. That is the main value of buying turnkey.

Most turnkey providers put all their money into cosmetics, not systems. Painting, carpet, and light fixtures are small cost items compared to termites, roof, plumbing, wood rot, electrical, HVAC, and foundation issues. For example, during the inspection of a flipped property, we learned that the plumbing system was shot and the flipper patched over leaks. Estimated cost to re-plumb the house, $10,000. In comparison, the cost for the paint and carpet and everything else was probably under $5,000.

I have also heard that some turnkeys do not provide an independent inspection report or allow the property to be inspected. Unless I know the actual condition of the property, how do I know the actual cost? Never buy a property without an independent property inspection, not the one recommend by the turnkey company.

One of the selling points for turnkeys is that they manage the property after the sale. The flip side is that you cannot use a different property manager, even if you are dissatisfied with their property manager's performance. While Yelp (and similar) reviews are problematic, read the turnkey's property manager's reviews. Once large turnkey's property manager had a rating of 1.5 stars based on a large number of reviews. Such a poor-performing property manager will result in more frequent tenant turns, more frequent maintenance, which generates more income for the property manager.

Another claimed advantage is that there is already a tenant in place. In the past, we purchased properties with tenants in place. Most were later evicted for non-payment of rent. In Las Vegas, eviction is quick and low cost. However, in some other parts of the country, an eviction can take over one year and cost thousands.

When I am investigating properties, I always talk directly to the tenant(s). On a few occasions, the rent claimed by the listing agent did not match what the tenant stated they were paying. The claimed rent was above market rate but what was actually paid was or below market rate.

Time to rent is another important consideration. The property could have been vacant for months. Or if the turnkey may have paid the tenant an upfront premium to move in a tenant at the stated rate. I've seen owners doing this many times in order to sell the property. In this situation, the tenant will move out once the lease is over, and you may be waiting a long time to fill the property at a lower rent than expected.

Another claimed advantage of the property manager is that they have an internal maintenance staff. This is an inherent conflict of interest. Property managers make more money on repairs than they do on rent collections. I do not want my maintenance costs be to the property manager's profit center.

If You Decide on Turnkey

I recommend the following as a condition of purchase.

• The right to have an inspection by an independent licensed property inspector.
• A list of all repairs made by the turnkey. You need to know which items (from the inspection report) still need to be corrected. Get a quote for all these repairs so you know how much the property actually costs.
• Get independent rental and sales comps for the property. This will enable you to compare market rent and property value vs. what the turnkey is stating.
• Get copies of their management and leasing agreement and read them. For example, I've seen terms requiring you to sell the property through the turnkey at a very high commission rate.
• You must have the right to choose the property manager. You want a property manager that works for you, not the turnkey. From what I have heard, you do not have that option with most turnkeys.
• Results from any code inspections. Also, what inspections are required to rent or sell. In some locations, the house must meet current codes. Meeting such codes may cost more than the value of the property.
• All disclosures provided by the prior owner of the property. In some locations, the seller must provide detailed disclosures on the condition of the property.
• A written statement from the property manager with specifics on the time and cost to evict a non-paying tenant.

If you obtain all the above, buying turnkey or direct becomes a simple time vs. return decision.

Hello Sam,

We've been working with investors for about 15 years and recommend a home warranty for at least the first year and sometimes more than the first year. Some comments on home warranties:

• Not all home warranty companies provide the same level of services. We've worked with many over the years, and most will do everything possible to deny all claims. Some pay the vendors so little that they put off warranty repairs until they have "dead" time. We know of only one home warranty company in Las Vegas that performs well.
• The first year you have a property in service is when you will have the most repairs. Normally, we do not recommend keeping a home warranty after the first year unless you have an expensive item that seems likely to fail - for example, the HVAC.
• In general, property managers hate working with home warranty companies. This is especially true if they have an in-house maintenance department. As a rule, never work with a property manager whose profit depends upon your having excessive maintenance.
• No matter who the vendor is, the property manager has to stay on top of them and ensure the work gets done on a reasonable schedule. If necessary, the property manager's job is to hound the home warranty company until the repair is completed. That may include the property manager calling the warranty company's regional manager or whoever they need to call to get things done.

Other comments:

• You mentioned you did not do all the repairs on the inspection report. That is normal for us. We evaluate each inspection report and advise our clients on which items should be repaired and what should not. In many cases, the items listed in the report are FYI's and nothing more.
• The two most important jobs a property manager has are finding a good tenant and controlling costs.
  • Finding a Good Tenant - There are VERY few property managers that have the skills to select good tenants. Screening prospective tenants is almost an art form. If the property manager does not have a written screening process they can show you, you need a different property manager. Their process it must include contacting the last two to three landlords or property managers. The tenant's current property manager is of little value. If the tenant is wonderful, they will say so. If the tenant is horrible, they will say the tenant is wonderful, just to get them out of their property. A good property manager will email the current landlord or property manager, knowing that it is doubtful they will get factual answers. The prior landlords are the ones who will provide the best information. But the property manager will not get it in writing. The property manager has to call them in person and ask the right questions. This requires some skill to read between the lines.
  • Control Costs - The property manager is responsible for controlling costs. Cost control includes doing only the necessary work, managing tenant requests, and using cost-effective vendors. If the property manager has an in-house maintenance department, count on your maintenance costs to be much higher than if they contract out all the work.

Based on what you said, I would look closely at your property manager. Find out who is doing the repairs and how the property manager is managing the tenant. 

I hope this helps.

Hello Patrick,

I recommend starting with a written set of goals and work backward to where you are today. It does not have to be lengthy, but you need to know where you are heading.

Also, look beyond the initial return. Metrics like ROI and cash flow only predict how a property is likely to perform on day one under ideal conditions. Such metrics tell you nothing about what is likely to happen beyond the first day; most people hold properties indefinitely so this is important. As to the property type, it does not matter. Let the numbers make the property selection for you. The best opportunity you find could be a townhouse, a multi-family, or whatever. Do not let dogma drive your selection.

The most important investment decision you will make is the location, not the property. Below are the key indicators of a good investment location.

• Appreciation - The number one criteria in location selection is appreciation. Inflation is constantly eroding buying power; each year, it costs more to buy the same set of goods. If you buy in a location where prices and rents are rising faster than the inflation rate, you will be able to buy the same set of goods because you will have the additional dollars you need from increased rents. When you are evaluating appreciation, ignore the COVID period. During the last year+, locations with low appreciation rates suddenly started performing. This is a blip and not a long-term change. If you buy in a location where prices and rents are increasing below the inflation rate, the amount of goods you can buy will decline over time.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

In Conclusion

Start with defining your goals. Remember that location is the most important decision you will make. After that, let the numbers drive everything else, not dogma.

...Eric

Hello Jennifer,

I believe the place to start is defining your goals. Once you define your goals, you can work backward to where you are today. Without defining your goals, it will be hard to know which of the option you are considering today will work best for you.

Your plan does not need to be complex or in any specific structure. Simply writing it down and making adjustments as you progress is all you need to do. The least you need to know includes:

• Your starting point - How much capital and credit do you have or expect to have in a reasonable time frame? Unless you plan to pay cash for your properties, get pre-qualified for an investor loan, so you will know how much credit you will have access to.
• The end goal - This is usually something like $10,000/Mo. income, in present value dollars.
• Time frame - The shorter your time frame to reach your goal, the more initial capital and credit you will need.

If you decide buying an investment property is the right option, the most important decision is the location.

The Right Location

Location is the most important investment decision you will make, not the property. I recommend selecting a location that best meets the following criteria.

• Appreciation - The number one criteria in location selection is appreciation. Inflation is constantly eroding buying power; each year, it costs more to buy the same set of goods. If you buy in a location where prices and rents are rising faster than the inflation rate, you will be able to buy the same set of goods because you will have the additional dollars you need from increased rents. When you are evaluating appreciation, ignore the COVID period. During the last year+, locations with low appreciation rates suddenly started performing. This is a blip and not a long-term change. If you buy in a location where prices and rents are increasing below the inflation rate, the amount of goods you can buy will decline over time.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

If you select a location that meets all of the about criteria, you are on the right path.

Summary

Start with defining your end goal and work backward to where you are today. I believe this approach will enable you to make the right decisions today.

...Eric

Hello Alleah,

The first step is to determine your real estate goals.

Define Your Goals and Resources

Without defining your goals, it will be hard to know where to start and see whether you can reach your goals. The least you need to know includes:

• Your starting point - How much capital and credit do you have or expect to have in a reasonable time frame? Unless you plan to pay cash for your properties, get pre-qualified for an investor loan, so you will know how much credit you will have access to.
• The end goal - This is usually something like $10,000/Mo. income, in present value dollars.
• Time frame - The shorter your time frame to reach your goal, the more initial capital and credit you will need.

Your plan does not need to be complex or in any specific structure. Simply writing it down and making adjustments as you progress is all you need to do.

For the rest of this post, I will assume that you want to create a reliable income stream to augment what you are currently earning or to replace your current earnings altogether.

The Process

There are 4 steps, which are illustrated below. The first decision is the most important, the location.

Location is the most important investment decision you will make, not the property. I recommend selecting a location that best meets the following criteria.

• Appreciation - The number one criteria in location selection is appreciation. Inflation is constantly eroding buying power; each year, it costs more to buy the same set of goods. If you buy in a location where prices and rents are rising faster than the inflation rate, you will be able to buy the same set of goods because you will have the additional dollars you need from increased rents. If you buy in a location where prices and rents are increasing below the inflation rate, the amount of goods you can buy will decline over time.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

If the location you are considering meets all the above, you are on track to be successful today and for the foreseeable future.

Investment Team

If you needed surgery, you would not start medical school. You would go to a surgeon. The same is true with real estate investing. Only a team can provide all the skills and resources required for successful real estate investing. See the diagram below.

The place to start is with an investment Realtor. But finding one will not necessarily be easy. While there may be thousands of residential Realtors in a city, there are usually only one or two investment realtors. Investment Realtors have all the skills of a residential realtor plus a lot more. Investment Realtors understand finance, market trends, ROI, tenant pools, and more. Investment Realtors also provide a wide range of services, including property selection and evaluation. Plus, Investment Realtors are always part of a team.

Next Steps

Alleah, with a location that meets the above criteria, and a good investment team, you should do well.

Hello Diogenes,

Excellent questions. I split my answer into two parts:

• Where is the best place to invest?
• What is the best approach to maximize future cash flow while minimizing income taxes.

Where Is the Best Place to Invest?

Location is the most important investment decision you will make, not the property. I recommend selecting a location that best meets the following criteria.

• Appreciation - The number one criteria in location selection is appreciation. Inflation is constantly eroding buying power; each year, it costs more to buy the same set of goods. If you buy in a location where prices and rents are rising faster than the inflation rate, you will be able to buy the same set of goods because you will have the additional dollars you need from increased rents. When you are evaluating appreciation, ignore the COVID period. During the last year+, locations with low appreciation rates suddenly started performing. This is a blip and not a long-term change. If you buy in a location where prices and rents are increasing below the inflation rate, the amount of goods you can buy will decline over time.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

The Impact of Operational Costs on Return

To demonstrate the impact property taxes and insurance can have on return, I put together the following example. This comes from an article I wrote a few years ago comparing two similar properties, one in Austin and one in Las Vegas. The formulas used in the example are:

• ROI = (Income - DebtService - ManagementFee - Insurance - RETax - PeriodicFees) x (1 - StateIncomeTax) / ( DownPayment + ClosingCosts)
• Cash Flow = (Income - DebtService - ManagementFee - Insurance - RETax - PeriodicFees) x (1 - StateIncomeTax)

Note:

• Neither Texas nor Nevada have a state income tax, so I left the state income tax out of the calculations.
• When comparing properties, you are unlikely to know about property-specific costs, like maintenance, vacancy, or renovation costs. The best approach is to leave these costs out of the comparison calculations. Once you zero in on a specific property, you want to include these costs.

Below are the assumptions for both properties.

• 20% down
• 4.5% rate
• 30-year term
• 3% closing cost
• 8% property management
• 0% state income tax. Neither Texas or Nevada have a personal state income tax.

Calculations for the Austin property:

• ROI = (1700 x 12 - 1024 x 12 - 1700 x 12 x 8% - 1625 - 6022 - 41 x 12) / (3% x 252500 + 20% x 252500) = -2.9%
• Cash Flow = (1700 x 12 - 1024 x 12 - 1700 x 12 x 8% - 1625 - 6022 - 41 x 12) = -1659/Yr. or -139/Mo.

Calculations for the Las Vegas property:

• ROI = (1490 x 12 - 1033 x 12 - 1490 x 12 x 8% - 450 - 1151- 41 x 12) / (3% x 255000 + 20% x 255000) = 3.3%
• Cash Flow = (1490 x 12 - 1033 x 12 - 1490 x 12 x 8% - 450 - 1511- 41 x 12) = 1,600/Yr. or $133/Mo.

As you can see, the higher cost of insurance and property taxes in Austin had a huge impact on profitability. You have to consider all the costs when you are evaluating properties.

Investment Team

Wherever you decide to invest, you will need a good investment team. If you needed surgery, you would not start medical school. You would go to a surgeon. The same is true with real estate investing. The diagram below shows the skills and resources required for successful real estate investing.

Working with an investment team costs you nothing and will save you time, money, and risk. If you would like qualification questions for evaluating a potential investment Realtor, contact me.

Also, if you have a good investment team in your chosen location, it does not matter whether you invest locally or remotely.

Appreciation or Cash Flow?

Whether it is better to focus on cash flow or appreciation depends on the location. Look at the pre-COVID appreciation rate. During COVID, locations that have had flat or declining property prices started increasing. So, ignore this period of insanity. Over the next few years, appreciation rates will likely fall back to what it was before COVID.

If a location has a high appreciating rate, focus on high appreciating properties. Rents will increase proportionately to prices, so cash flow will increase over time as well. When you have accumulated enough equity, refinance the property and buy another property. Refi loans are not taxed, so you can use all the accumulated equity. This is the fastest and most reliable way to acquire a long-term reliable income stream.

If the appreciation rate was below the inflation rate, buy properties for high cash flow. Inflation is constantly eroding buying power, so your initial cash flow will be the highest you will ever receive (adjusted for inflation) from that property. If the cash flow is high enough and you plan to hold the property for a short period, this approach also works. Just factor into your calculations that all rental income is taxed at regular income rates, and you will have additional costs when you sell the property.

I frequently hear, "You can only count on initial cash flow." To a degree, this is true. However, suppose you buy in a location that appreciates below the inflation rate. Almost nothing can reverse the downward trend; you can count on the market to continue declining along with your inflation-adjusted income.

Can you count on a rapidly appreciating market to continue? It depends on what is driving the appreciation. If appreciation is driven by an increasing population combined and an increasing number of good jobs, it will likely continue. The best indicator of a solid market is if inventory levels are symmetrical to price increases. Below are two charts: one showing appreciation and the other months of inventory for the property profile we target in Las Vegas.

As long as you see such symmetry between prices and inventory, it is real, not a bubble. During the 2008 crash, prices were rising rapidly, and so were inventory levels. This demonstrated that prices increases were driven by speculation, not real demand. It was a bubble.

Diogenes, I hope this helped.

...Eric

Hello Angeli,

The Texas and Nevada markets are very different. In an article I wrote a few years ago, I compared a Las Vegas and an Austin property. The comparison may help you to decide.

Below are the assumptions for both properties.

• 20% down
• 4.5% rate
• 30-year term
• 3% closing cost
• 8% property management
• 0% state income tax. Neither Texas nor Nevada have a personal state income tax.

Calculations for the Austin property:

• ROI = (1700 x 12 - 1024 x 12 - 1700 x 12 x 8% - 1625 - 6022 - 41 x 12) / (3% x 252500 + 20% x 252500) = -2.9%
• Cash Flow = (1700 x 12 - 1024 x 12 - 1700 x 12 x 8% - 1625 - 6022 - 41 x 12) = -1659/Yr. or -139/Mo.

Calculations for the Las Vegas property:

• ROI = (1490 x 12 - 1033 x 12 - 1490 x 12 x 8% - 450 - 1151- 41 x 12) / (3% x 255000 + 20% x 255000) = 3.3%
• Cash Flow = (1490 x 12 - 1033 x 12 - 1490 x 12 x 8% - 450 - 1511- 41 x 12) = 1,906/Yr. or $163/Mo.

Include all major costs when comparing properties

As you can see, the high cost of insurance and property taxes in Austin had a huge impact on profitability. This is why including all major costs is important. If you do not, the numbers generated can be way off reality.

Below are the formulas we use for comparing properties:

Below is an explanation of the variables:

• Income: The monthly rent x 12.
• Debt Service: 12 x the monthly mortgage payment (principal and interest).
• Management Fee: Management fee percentage x annual rent.
• Insurance: Estimated annual landlord insurance.
• RETax: Annual property tax.
• Periodic Fees: The sum of all periodic fees. For example, the HOA dues.
• State Tax: Nevada has no state income tax so this is always zero. If you are comparing a property in Nevada to one in another state, use the appropriate tax rate for that state.
• Down Payment: For a financed purchase we use the down percent x the purchase price. For cash purchases, it is the total purchase price.
• Closing Costs: We use 3% x purchase price for financed properties and $2000 for cash purchases.

What about formulas like the rent/price ratio? See the calculation below.

• Austin: 1700 12 / 252500 = 8.1%
• Las Vegas: 1490 x 12 / 255000 = 7.0%

As you can see, the result is invalid. The Austin property has a much lower rate of return than the Las Vegas property. The rent/price ratio is simply wrong because it does not include all the costs.

Another consideration is a local investment team.

If you needed surgery, you would not start medical school. Also, not just any doctor will do. You want a surgeon that specializes in the kind of surgery you need, not a general practitioner. The same is true with real estate investing. You want to work with an investment team that already has the skills and contacts. Good investment teams are hard to find. The place to start is with an investment Realtor. Know that even in a large metro area, there is likely only one or at most two investment Realtors. While finding an investment Realtor may take time, the cost, risk, and time savings will be worth it. See the image below for the range of skills you need to be successful.

Whether you decide on Texas or Nevada, find a local investment team. A good investment team will save you time, money, and risk.

...Eric