Real Estate Investing – Local Or Far Away – The Common Denominator

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Last week’s post about the decision, or rather preference real estate investors have for where they invest, delivered a priceless comment thread. Those who preferred the best market possible in which to invest were met, point for point by those who wouldn’t leave their local market if the Lord Himself came down and ordained it. In a word, it was fantastic. Better yet? That comment thread demonstrated a common bond between the two clearly divided schools of thought.

Comfort Zone

We can talk all we want, but for the most part when it comes to investing in real estate for the long term, we figure out ways to remain in our personal comfort zones. Sometimes even empirical analysis won’t budge us — first hand observation won’t change our minds. Sometimes it’s the natural consequence of how we were originally taught, even mentored. Other times it comes from within.

The key factor we all must understand is that there IS no wrong answer — with one glaring exception.

We can’t be made to violate our comfort zone. Period, end of sentence. If an objective reader could glean anything from that thread, the obvious existence of the commenters’ comfort zones was it.

Think about it objectively for a minute.

In fact, I’ll go first. How difficult do you think it was for me to completely abandon my own market, professionally speaking, almost a decade ago? The reason I took that drastic step was that by all objective analysis I wasn’t doing investors any good by telling them San Diego was still a ‘great market in which to invest’. It simply wasn’t true any longer, not matter the method of analysis employed. The comparative analyses using several different far away markets was damning to say the least. My life was a mess for two years due to that decision. Folks thought I was, um, misguided to say the least. Now? Not so much.

But don’t take my word for it.

If you wanna get started as a serious long term real estate investor in San Diego, here’s what you’ll find. Let’s start with a modestly priced and relatively well located duplex, a few minutes from my office. Let’s take the one in which my own daughter now lives. It was built around 1952. Its floor plan is laughable. The kitchen? The poster child for functional obsolescence. Prices in San Diego have consistently gone southward on the chart since the original bursting of the bubble, with one short, mean-spirited exception. At the top, these duplexes consistently sold in the range of $540-575,000. Now? There are a few on the market for between $325-360,000. Their rents are roughly $2,400-2,600/mo total.

At say, $350,000 using the required 25% down, the investor would need $87,500 + closing costs. Let’s call it $95,000, give or take. What you get, to cut to the chase, is a 75% loan at the current investor rate of 4.625%. That’s an annual debt service of about $16,200. Rents are $31,200 a year. Using a vacancy/operating expense factor of 40%, we come up with a Net Operating Income of $18,720. That means that our cash on cash return is $2,520 annually — or, if you prefer, 2.65%.

The same thing in a state almost three hours away by air offers the following menu option for this first time investor.

This duplex is brand new. The monthly total rents are about $2,700. The location quality is empirically superior to the San Diego example. They offer 2-car garages for both tenants. In San Diego the tenants share a 1.5-car garage. The kitchens in the other state are state of the art, as are the floor plans. And the list goes on. The price for this outa state property is about $263,000 or so. Let’s see how it compares to San Diego’s offering.

25% down + closing costs = around $73,000, give or take. If we use a 50% vacancy/operating expense factor (25% more than we allowed SD’s duplex), the cash on cash return would be around $4,030 — or roughly 5.5%.

Let’s review

This newbie investor’s first investment will require either $95,000 — or — $73,000 initial cash. The San Diego duplex’s cash on cash return will be less than half of the outa state option. Also, just to make a point, I actually used less vacancy and operating expenses on a half century old property than I did with the brand new duplex. Yet the far away property slaughtered the cash flow by doubling the cash flow of it’s ancient San Diego cousin.

Now do you understand why I left my hometown’s real estate investment market? I couldn’t look folks in the eye while advising them to keep their hard earned capital in the ‘I can drive by them’ market, hometown or not.

Yet when I told my clientele of my intention to abandon San Diego’s market, just under 35% of them bought into my analysis. The rest chose to remain. Their almost visceral need to drive by their properties overcame objective analysis. Put more fairly, they would not violate their comfort zones. At the time I supported their decisions without reservation. Since then some have had a change of heart, but most remain deeply committed to San Diego. This, in the face of massive loss of net worth, cash flow, and the sinking feeling that their cash flow projections for retirement have been gutted.

Does this one example prove anything about the pros and cons of investing local or far away? Not in the least. Your particular market might be close enough for jazz compared to other, sexier markets. There’s nothing magical about either school of thought. The only school of thought that matters a wit are two:

1. We must all steadfastly remain inside our own comfort zones. We can expand those zones by our own volition, but we must remain inside them.

2. The consequences of the investments made, dictated by those same comfort zones may not be as comfortable as we’d hoped — yet they will remain the consequences.

And there’s the rub

For decades, investment capital flowed into San Diego like an overflowing waterfall from not only all parts of the nation , but of the world. That same capital is now headed elsewhere, and for good reason. If someone had come to me at any time between 1976 and 2003, with the goal of convincing me there was a superior market to San Diego? I’d of laughed out loud — and I had the empirically historical numbers to back up that mirth. Our market rocked!

Stay in your comfort zone for sure. But try this at the same time. Test your comfort zone as it relates to the ultimate consequences of your decisions. Will this investment decision have a deleterious affect on your retirement income, relatively speaking? The answer to that question is often the catalyst for the expansion of our comfort zone.

Again, there’s nothing magical about staying local or going far away. Just ensure you understand the end game results as it relates to your retirement income. After all, that’s why you chose real estate in the first place, right?

Right.

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

4 Comments

  1. I am enjoying the posts and enjoying having my mind and comfort zone expanded.

    A couple of things I would share:
    1) Don’t go out of town for the sake of going out of town. Go out of town because the numbers and opportunity are far superior to your own town. As you point out with San Diego, what was great years ago is no longer great. Do your homework on your own town and other prospective markets. Today in my area, there are too many opportunities for me to consider an out of area investment. In two years, that may not be the case. Always be looking at the numbers, they change from month to month and year to year.

    2) If you are a newbie, I would get experience with rehabbing and property management locally before I would venture out of town. You need to know how to evaluate and hire contractors. You need to know how to evaluate and hire and fire property management companies.

  2. Great points, much in the spirit of the previous post. I think the tendency to stay local, in addition to being a comfort zone issue, has alot to do with our natural, obssessive need to micro-manage. This is particularly evident in people who’ve been burned, or heard burn stories, and remain confident that nothing can work unless they do it themselves – and so “boots on the ground” often translates to “hand in everything”. While this certainly helps when starting out, there’s comes a time (and a portfolio size) when this is no longer possible, even if you’re staying in your back yard all your life – there’re just too many fires to put out and too many mini-projects to begin, supervise and complete on a daily basis – you simply must delegate.
    And once you’ve started delegating, is there really a difference if you’re doing it on the phone to someone three blocks, or three continents away? Once you’ve done your DD, honed in on an area and the best possible team in that area, I propose that difference is zilch.

  3. Cher Donovan on

    Agree with Gary on watching the numbers and having some experience managing. PM’s, no matter how good they are, respect an owner who knows something and gives them some direction.
    Re: Ziv’s statement about “micro managing”: I have seen that “chemistry” and the level of micro managing is one of the criteria that one needs to consider when picking a PM. We visit our properties frequently so the manager knows we are paying attention. I am especially interested in the design decisions: Carpet, paint colors etc. I set a limit on what a PM can spend out of the reserve account without permission. I like to be consulted about large repairs such as HVAC, pool repairs etc and to suggest vendors and review estimates. This way the PM has perimeters and doesn’t have to call for day to decisions. They also call when a new tenant is chosen to “run by” the DD. I rarely second guess a tenant, but hearing about the tenant keeps me connected and I get a chance to congratulate the PM on a good choice. Sometimes the PM will be on the fence in a tough market about renting to a marginal tenant, but not wanting to have a longer vacancy will present the facts to me and we will decide together. I think it is important to be a support and an ally for the PM and not a nit picker. Like Ziv said, if you have a fear because of hearing other’s horror stories, it can color your perspective and you can be suspicious of even a good PM. This colors your relationship and they really feel it in your attitude. When I hear bad things about a PM from other owners, I have to take a few steps back and look at MY relationship with them. Sometimes another person will have a bad experience, but mine will be positive. Chemistry is a big factor.
    And picking your battles…you only have so many or the PM will label you as a “pain in the butt”. I have to remind myself that they have many other owners to deal with besides me. So I let some things go. It’s the bottom line. If cash flow is coming in, the fact that they paid $50 for a faucet that I could get for $40 by hunting around is not a cause to go ballistic. It IS going to cost you more to have professional management than doing it yourself. That freedom comes at a price!

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