Investment Property Location: Don’t Dismiss the #1 Rule in Real Estate

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“Location, location, location!”

You understand the importance. It’s the number one rule in Real Estate.

Yet when it comes time to choose between a high cash flow property in a less desirable neighborhood versus one with a lower cash return but in a great location, you naturally start questioning the age old adage.

Why does location matter? To understand, you have to look beyond the initial numbers.

The Inherent Value of Location

While real estate values don’t fluctuate to the degree stocks do, its value still rises and drops in cycles. In up cycles, well located properties appreciate sooner, at a higher velocity, and maintain the momentum over a longer period of time. In down cycles, these same properties are also the last to take the hit. Because of their location, they tend to sustain their values. Alternatively, a property in a poor location will experience just the opposite. But what does this really mean to you, the investor?

Most investors buy and hold for the long term — the hope is that the property will appreciate to a point that reaches their target goal. Because real estate is illiquid in nature, when such a large sum of money is committed, you obviously want assurance that the investment will maintain its value over time. The desire is to cash in the chips and recoup your initial investment and profit some too.

Properties in poor locations experience the biggest swings in value over a longer period of time, and these investments typically become a race against time to recover fully before the next down cycle arrives. Properties in better locations, however, will have had a head start during the up-cycle in the race for appreciation.

While many investors intend to buy and hold for extended periods, oftentimes they are forced to prematurely sell their property. If you have a property in a desirable location, you reduce the risk of selling the property at a loss.

Cash Flow and Property Location

Investment property value is tied to its rental income. If rents increase, then appreciation occurs. As you guessed, rents are directly correlated to property value.

Let’s take the statement described in the previous section but replace “value” with “rents”:

In up cycles, well located properties have rents that rise sooner, at a higher velocity, and are maintained over a longer period of time.

Well located properties are typically located nearby employment centers: a particular area with a concentration of jobs. People first seek out locations that are close to employment centers; these areas are first to experience growth in rents. Properties in areas further away don’t experience the same rise in rents until renters are priced out and forced to look farther. If rents begin to decline, properties closest to the employment center have a better chance of sustaining their rent values. Following that logic, if your property is in a poorly located area when the economy sours, then not only have you lost substantial equity due to loss in value, but you’ll also experience less cash in your pocket each month. Your cash flow will continue to stay low until demand again spills over to your area.

Connecting the Dots

High cash flow properties are tempting because of their initial high return. However, keep in mind that if you’re holding for the long term, then know that a property’s value and cash flow will rise and fall. If the property cannot consistently sustain its high cash flow, its value will plunge too. In the end, your overall rate of return may end up being much lower than anticipated.

It’s easy to dismiss the location factor when staring at a property with a high cash return in a less than desirable area. However, numbers itself cannot explain the entire investment picture. While none of us can predict the future, what we can predict with certainty is that a good location will likely stay desirable for many years. While there are many unknown risks when evaluating potential of investment properties, choosing a favorable location will reduce their impact.

About Author

Joey Wang is a Commercial Real Estate Investment Broker with Cornish & Carey Commercial Newmark Knight Frank. His team--Apartment Advisors--is composed of seven dedicated multifamily sales professionals working closely with C&C sale professionals from other disciplines, to provide a premier level of service to institutional and private investors and developers across Northern California. Since 2000, they have transacted over $1 billion in volume and over 10,000 units. He may be contacted at [email protected]

17 Comments

  1. This “conventional” advice may sound right, but in reality it is not.. its too simplistic.
    If one is buying properties for income, cash flow is of a paramount importance, location comes second. If one buys the property to gamble n for appreciation, than I can agree, location is one’s best bet .. but one has to commit to negative or low cash flow.
    I live in what you would call “Nice neighborhood” my residence cost 800k +, the best rent I can get for it is 3,5k per month.

    My rental properties are in what one would think undesirable neighborhood, but the property that I buy for 230k brings 4k per month. I want author to tell me, which one he would choose based on the return on investment.
    My 2c

    • Poorly located and high cash flow properties can and do work for many investors. Each investor’s situation, experience, and hands-on management style is unique so it’s important to find the opportunities that will fit their criteria. Ultimately, it’s finding a investment property that balances cash flow vs appreciation vs hassle vs liquidity to achieve the investor’s investment objectives.

  2. Who says the “#1 rule in real estate is location, location, location”? All I hear harping this seems to be the real estate agents – not the investors. I prefer the #1 rule of real estate to be “cash flow, cash flow, cash flow” that is how you get out of the daily rat race!

  3. I have been looking for income property for almost 2 years, I avoid nice, big, and cheaper house in central California, and choose to look for opportunity in silicon valley, where the job is; but I have been paralyzed by the choice between good or better location with negative cash flow vs. undesired location with possible positive cash flow; I like better location, but worrying that it would be a trouble maker if property value stay flat for a long time, or if I lose job…

    I guess that I have to find a comfort zone….

    • Do what is comfortable for you, but do not go by your gut feeling .. your gut doesn’t know a thing. Although, your brain can collect and digest information and make a rational decision.
      Undesirable location in your mind is quite different from what people in a particular neighborhood consider desirable. One of my tenants is a nurse, who makes 130k. He can live anywhere hi likes. He rents my 1bd apartment for 1k (in from my point of view, undesirable location) because there are ethnic foods and people of his ethnicity in this area.

      I started out in rental business in “undesirable area” in 2009, as a hedge against loosing my contracting position. Now I own 6 multifamily properties and gross 18k per month. I did find a job eventually, but don’r cherish it as much and don’t afraid it to loose as much as before.

      Explore the neighborhood, come around at different times. Learn what is the going rent vs. cost of the property, and if its favorable go for it. It maybe hassle and learning, but you can get out of it more than you expect. I definitely did. After 30 years at high tech jobs, nowhere I earned a pension comparable to the cash flow I get from 2 years of investing.

  4. I agree with what you said. I have a property in a less than desirable area and I get bad tenants. On the other hand, I am an agent in a prime location and it’s a matter of time before our properties get rented with good paying tenants. The best situation is to buy in a good location with great numbers.

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  6. You could also invest in other states that have great areas where you get cash flow and have a great location.

    I get many investors from out of state that invest here in Georgia because they can achieve the mix of cash flow and location they can’t find in their state.

    Your return and mindset on what constitutes a “deal” is based on many different situations and there is not a “one fits all” answer.

  7. Out of State investement sounds logical, but I am not big beliver in remote property management. There is not much money in property management comissions. So, to assume that anybody who is hired to manage your property with the rigor that would be even a fraction what the owner would do is a huge maybe. That is unless this is someone that you know real well or related to .. I had one remntal property 60 miles away .. and it was a problem ..
    You know that U are not going to drive 120 miles round trip to check on 150$$ charge .. and so are .. so it all bolis down to knowing who you entrust your inverstement few thousand miles away

  8. Leonard,

    I am not talking about one off properties located in far away areas that are houses.In that respect I agree with you in that you get agents who do it for a little coin and do not want to manage very well.

    I don’t do management because I make much more doing transactions.For remote areas I would buy a larger project with a professional management company in place where that is all they do and are trained specifically in that asset class.

    • I agree with Joel. If you’re going to invest out of state, then the acquisition focus should be large properties to support both on-site and off-site property management while still providing an acceptable return after all fees. SFH rentals should really be reserved for local investment only.

  9. lot of good discussion and useful info.

    As a newbie, I would start locally with 1-4 units, or SFR, unfortunately, good deal is hard to come by, there are always multiple offers, have to make offer 10-15% above listing price.

    where and how to get good deal?

  10. This is true, lately in LA area are multiple offers.
    The last 4 plex I got I paid 15% more than the listing price as there were 22 offers .. and this was cash offers only .. I lost 5 other offers .. numbers got too high in the bidding war
    .. It does not matter, Just know the number that makes sense to you .. and don’t bid over that number.

  11. Leonard,

    Hopefully I can be as successful as you are, I made some cash offers as well, sometimes cash has adventage, sometimes don’t.

    When you do your math (cash flow analysis), do you based on all cash, 25 or %30% down? what is most important criteria.

    If the number is good to you, would you get the house next to freeway, or railroad etc.?

  12. “If the number is good to you, would you get the house next to freeway, or railroad etc.?”
    1. Short answer is Yes .. I would stop at buying if the property in ON railroad though 🙂
    Long answer, analyse impact of the negative location on the price and rentability of the property.
    In fact, I just have made an offer of the 3plex on a very busy street. However if they take the price I have offered 15% less than asking price, I can afford lower the rents to the point were ,in a rent price sensitive area, there will be takers and I will still meet my ROI criterion.
    2. I do look at the cash on cash return(no matter what is down). However, property purchased for cash can be reinanced and cash on cash numbers will change.

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  14. Tom, I noticed a couple people asking for your spreadsheet- if it isnt too much trouble could you send it my way also? I would really love it. I am sure it took some time putting in the formulas and linking the cells together, I have a great appreciation for good Excel work! 🙂

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