How to Know if You’re Investing in the Wrong Real Estate Market

by | BiggerPockets.com

Today the question is this: How do you know if you’re investing in the wrong market? 

I’m probably going to sound like a broken record here, but it is very, very important that you build trust and relationships with the key people who are going to be involved in your real estate ventures. For example, you need to have a good real estate agent, property management company, accountant, and possibly attorney. You need to have contractors, a rehab crew, a title company, advisors and mentors. You need to be part of a real estate club, and you need to be part of an online community. Don’t forget your network equals your net worth. 

Success won’t happen overnight. It is going to take five, 10, or 15 years to build a lasting portfolio that will be able to offer you financial freedom. You also want to work with people who understand what delayed gratification is and what planting a seed now and reaping the harvest later is.

So how do you know if you’re investing in the wrong market? My experience has led me to believe that I should forget about all the online stats and demographics. As I mentioned to you, the team is by far the most important thing. So, let’s just hypothetically say that you have found the right team in a particular market that you have researched. Then, you need to get down to the fundamentals. That means cash is king and cash flow is queen, and you can forget about appreciation because that is a crystal ball analysis. We do not know what tomorrow brings, so you cannot include any appreciation estimates into your calculations.

Related: Here’s Why the Market is Exactly Where It Should Be

You may think what I’m going to share with you won’t work in your market. Look, I understand because I attend a lot of conferences nationwide, and a lot of these institutional companies and buyers are talking about a lack of inventory in markets that have a seen big appreciation. I get it. Well, then don’t invest in that market. It’s as simple as that. Invest in a market where the numbers make sense and just focus on the cash flow. That is my belief, take it or leave it, but I do not believe in appreciation. I do not believe in speculation. I believe in the core fundamentals of a deal as it lies today.

For the Hands-Off Investor

In order for a market to make sense, you’ll need to follow the numbers. If you are not getting numbers that work, then you are in the wrong market, period. If you are buying turnkey or buying a renovated property through a real estate agent, it is my belief that unless you are making 8 percent in net cash flow, then you should not do the deal and you should not invest in that market. Again, 8 percent net return on investment. I also want you to include a margin of safety where you are overestimating your expenses like maintenance and vacancy deductions. What are some of the deductions when you’re calculating your ROI? You have hard costs like property management fees, insurance, and property taxes. Then the unknowns are the maintenance, vacancy, and CapEx, unless the property has been recently renovated, and then you can include those costs in there too.

The rule of thumb is to overestimate your expenses and underestimate your income. Once you have done that and the numbers on paper produce less than 8 percent net return on investment, don’t touch the deal. That is my honest belief. You’ve got inflation coming at you at 2-3 percent every year, so you want to be making some kind of money. You still want to minimize your risk as much as possible or you might as well take your money and put it in an index fund. If you want to be as hands off as possible, you need 8 percent net. Unless a market offers those numbers, forget about it.

Related: Why “Overpriced” Markets Like San Francisco May Be Healthier Than You Think

For the Hands-On Investor

Next, if you are like me and are happy to get down and dirty and do deals, then begin to hustle and negotiate. Also, send out a lot of yellow letters and not buy properties on the MLS. Try to keep rehabs to a minimum. Personally, I would not get out of bed unless I am making a 15 percent net return on investment. Those are the numbers that I do if I’m buying and holding for my portfolio. I encourage you to reach out to me because I am happy to show you the numbers that I am doing in my market. Again, that’s going to come down to finding a property and buying it cheap because you make money when you buy, not when you sell. You want to buy it for as cheap as you possibly can. Remember, rehab always goes over budget.

So, I buy cheap and I negotiate well. Then, I rehab to an average standard and have my property management company to manage. Remember, I won’t do the deal for my own portfolio unless I am making 15 percent net. A lot of people ask me what I’m doing in Toledo. I say I’m here because the numbers make sense, and I moved here from Australia because it was a once-in-a-lifetime opportunity. I just don’t know of any other market where I can find a better return on investment. It’s all about the Midwest, period. That’s where the deals are and where the cash flow is. Forget about appreciation. Focus on the core fundamentals of that particular transaction as it lies today.

If you live in an expensive market where you can’t find these numbers, move to market where you can. I did it. It’s a sacrifice, but nothing comes easily, especially if you want financial freedom.

Hate it or love it? I welcome your criticism. I welcome your comments. Please feel free to comment below.

Am I right? Am I wrong? I’d love to hear from you.

About Author

Engelo Rumora

Engelo Rumora, the Real Estate Dingo and your favorite Australian, quit school at the age of 14 and played professional soccer at the age of 18. From there, he began to invest in real estate. He now owns real estate all over the world and has bought, renovated, and sold over 500 properties. He is currently in the process of launching an ICO that will “Decentralize The Real Estate Industry.” He’s also known for giving houses away to people in need and his crazy videos on YouTube. His life’s mission is to be remembered as someone who gave it his all and gave it all away.

12 Comments

  1. Nancy Roth

    “It won’t happen overnight. It is going to take five, 10, or 15 years to build a lasting portfolio that will be able to offer you financial freedom.”

    Thank you for saying that. I get tired of articles or seminars with titles like “How I made a million dollars in my first six months of [fill in the blank: wholesaling, flipping, rentals, buying notes etc.].” That is so not what it’s been like for me. I’m in my sixth year in this business, and just starting to get a clear head about what I do best and want to do more of, after years of hard work and hard knocks, trying different things learning things and trying again.

    Your advice for working in rental cash flow markets is right on target, but I want to put in the caveat that the high-priced appreciation markets work also for certain investors, and that is not based on speculation. Its like the difference between stocks and bonds. You buy bonds for dividends (cash flow) and stock for value gains (appreciation). there is a place for both of them in the ecosystem of commerce, and the same goes for purchases in low-appreciation markets and high-appreciation markets.

    • Cam Robert

      Nancy – spot on re: patience and time. Also agree with you on the debate between cash flow vs. appreciation. To add to to what you’re saying, I think it’s really a question of what assumptions you believe about the future. Even if you’re investing for immediate cash flow and saying ‘I don’t need appreciation’, what you’re also implicitly saying is that you believe the market you’re in will at least be stable going forward (I.e. not declining). Still requires an assumption about the future. Contrast this with assumptions for high growth markets and you realize all you’re saying is that you believe the market will grow in the future. Which could also be a perfectly valid assumption about the future for that market. Key is knowing what type of market you’re in, and what assumptions about the future are reasonable.

      I love Midwest properties for cash flow, but also realize that even a few extra percentage points of growth in rents and property value can make for very compelling returns in the high growth markets – you just might forego the cash flow today. If you’re interested I created a calculator that allows you to compare the returns of a yield oriented property against a high growth appreciation oriented property – this really helped me to understand the trade off: https://ramenretirement.com/2018/05/16/yield-growth/

      Also – FWIW, there’s a very good argument why certain high growth markets like SF / Bay Area, while seemingly expensive, still have plenty of room to grow in rent and property values: https://ramenretirement.com/2018/04/24/sf-affordability/

  2. Barry H.

    I believe we have similar philosophies Engelo. I have a partner/friend who in the early 2000’s always leveraged (borrowed) and “banked on the equity.” He continues to put in sweat hours to save his cashflow to this day. Fortunately, he is a hard worker and he survived the real estate recession. He has paid off nearly all his debt and will soon sell a few more properties.

    I was (am) a cash only buyer, but I left AZ (hot market) in 2016 because, as you state, the ROI for buy/hold properties (cashflow) is just not there. I have friends making $$$ on flips here in AZ and more power to them – but it is not steady income. As Nancy Roth pointed out, the hot markets are like stocks which pay big when you sell (or lose big in a market downturn).

    The Midwest is a steady market for low cost properties which have a fairly predictable cashflow quotient. That said, especially if you are an out-of-state investor, establishing a team is the most difficult part of turning the corner to positive cashflow. It has taken me almost 2 years to establish my team and I kissed a couple frogs before I met my royal family (team).

    Very concise article and to the point – good advice. Moving from Australia is a big move. It appears to be paying off !!

    • Cam Robert

      Hi Ryan – I don’t invest directly in Dallas (only through partnerships) so I’m not as deep on the different sub-markets, but my experience from other Midwest markets is that those $30K properties are in the really rough neighborhoods – higher crime, higher vacancy, lower rents. There’s a reason properties are being sold for $30K or less, and it’s not because the seller is a generous person who wants to make you rich. It’s because the economics (after all expenses, maintenance, capex, vacancy, management headaches) probably make those properties very difficult to make money on. You likely need to be on the ground and intimately familiar with that sub market to know what you’re doing and make money. I don’t know the author, but from what I’ve read, he has gone deep in the NE Ohio market, so he’s probably able to navigate those choppy waters effectively. If you can do it, there is potential for great returns (I am a partner in one fund that invests with the same strategy – workforce housing in the rust belt), but need to have your sea legs, boots on the ground, and a great team behind you.

      Generally speaking, I would say if you don’t know implicitly where the $30K properties are in the market you’re investing in, then either your market doesn’t have them (see: San Francisco), or you don’t know your market well enough. Dallas is a big market, so it might be that the sub markets you’re familiar with don’t have those types of neighborhoods and properties, but I suspect there are a few somewhere in the Dallas MSA. Just be careful what you wish for. Good luck!

      • Engelo Rumora

        Hi Cam,

        “higher crime, higher vacancy, lower rents. There’s a reason properties are being sold for $30K or less, and it’s not because the seller is a generous person who wants to make you rich. It’s because the economics (after all expenses, maintenance, capex, vacancy, management headaches) probably make those properties very difficult to make money on.”

        I would disagree and I’m sure that many other experienced Midwest investors would disagree also

        My entire staff including myself live in the exact same areas we transact in and so far none of us have a “teardrop tattoos” under out eye 🙂

        Thanks

      • Jason Daleo

        Hey great post! I took your advice and started looking in Toledo for multi family units but they mostly seem on top of each other and the school districts are no higher than a 2. What would you recommend for a new investor like myself to do to learn the best areas to invest in, especially not knowing the area or pricing? Thanks.

  3. J. Lee

    I completely agree with your analysis. I invest in rural Midwest as well (central Illinois). Originally, I set my target at 30% cash on cash roi with extremely conservative assumptions (underestimated income and overestimated expenses), but now that I have worked out a way to lay 10% down as Opposed to original 20% down I seek 60% return. I get this from the way I select and negotiate properties. Possible in my area (not easy) but definitely can be done. I have went from 0 to 30 units this way in a year (partial houses and partial multi family).

  4. Richard Feeley

    Well said. Lived in Midwest for 26 years, Michigan specifically. My experiences all through that State confirm what you said. Great prices if you’re willing to relocate. Especially if you have good contacts and know where money is being invested in your market.

    • Engelo Rumora

      Thanks Richard,

      Michigan is a great market.

      Probably better than any other due to the bad stigma surrounding Detroit for so many years

      Detroit sure has blossomed and it’s amazing to see the transformation

      Much success

  5. Patrick Liu

    Hello Engelo,

    I would like to know if what you suggest would work in a long distance setting. For example between states or province where I live. I understand you moved from the other side of the World over.

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