Most members and readers of the Silicon Valley Investors Club live in the Bay Area, where it is no secret that real estate prices are sky-high. Despite the pandemic slowing price and rent growth in major cities, the Bay Area remains one of the nation’s least affordable places to live – RefiGuide reports that San Francisco is the #1 least affordable city in the country, with San Jose coming in at #7. In the area, it is difficult to buy not only a primary residence, but also investment properties. Not surprisingly, many of my friends in Silicon Valley are seeking to invest their paychecks elsewhere.
I face a similar dilemma in my current city of Chicago, where housing is much more affordable than it is in the Bay Area. Despite this, the city is experiencing significant outmigration – that is, people are moving out faster than those moving in, which does not bode well for real estate. These conditions render me skittish toward investing here, so I take my money elsewhere and invest where I think it makes sense.
Investing out of town is not easy. However, I believe my thought process and strategy to pick the proper market can be helpful for others in a similar boat, no matter where you live.
Steps for Picking the Right Out-of-Town Market:
- Have a data-driven hypothesis. Having clear ideas about the metrics you want to measure before starting your search will save time, and perhaps money, in the future. For example, as I implied in my comments about Chicago above, stagnant population growth might not necessarily be a bad thing, but a declining population is probably a red flag. Note, the goal of a hypothesis is to have a statement that provides you with a clear rationale for why you are picking a market that will help you ride the short-term ebbs and flows every real estate market will go through. An example hypothesis could be, ‘I think state capitals are great investments, because of the large concentration of government workers and locations generally close to universities and young professional talent. For instance, I could invest in Sacramento, where 25% of the workforce is employed by the state, and its proximity to the expensive Bay Area makes it an ideal place for cost-conscious remote workers.’ If the Sacramento market, or other state capitals, faces a recession, you have to ask yourself if your hypothesis still holds true, and if so, then you know you need to stay in the market and continue to invest.
- Determine exactly what you are looking for, so you can pull the trigger quickly when the right opportunity comes along. This requires knowing yourself, what you are looking for, and your risk tolerance. Investing in a rust-belt city will likely offer you higher, consistent cash flow than buying in a Sunbelt city with high population growth, but that cash flow comes with a higher risk. Are you willing to accept that additional risk? On the flip side, buying in the Sunbelt will likely offer you higher appreciation potential, but you will have to pay more for it. Are you willing to let go of more cash upfront? Moreover, are you looking for single-family homes, small duplexes, or something else altogether? I suggest you go nothing larger than 2 units when you first start investing out of state, because each additional unit adds additional complexity.
- At first, cast your net far and wide. Start broadly. There are many smaller cities and towns all over the US that would make fantastic investment opportunities, not all of which you might have heard of before. Based on what you are looking for, you can find some places that really surprise you.
- Know your target market intimately. Once you narrow down your search, it is time to go deeper. If you do not know your market well, then partner with somebody who does. Know particularly the “path of progress.” If you see two neighborhoods rapidly appreciating in value with a lagging area between the two, perhaps that area lies in the “path of progress,” and you should investigate further. As an out-of-town investor, it may not work well to drive through these areas yourself, but the crime map on Trulia provides a great high-level overview.
- Find the right partner, particularly the right property manager. Property managers have the most immediate data about cash flows. In my experience, they are also the quickest way to create or destroy value. In fact, I have seen formerly glorious mansions fall into utter ruin after years of mismanagement, in which the investors were out of town and never checked on their properties. Do not let this happen to you. Conduct your due diligence thoroughly by checking online reviews and asking for references. Make sure you are on the same page regarding values, operating philosophy, and communication style. I would highly recommend lining up the right property manager before you ever bid on a property.
Considering Short-Term Rentals?
I would be remiss if I did not discuss short-term rentals (STR), particularly due to how popular they are becoming. Working for Andes STR, a short-term rental property management and investment company, I believe that STR are the future of real estate investing. According to Forbes, the STR market grew by more than 100% in the three years leading up to 2019. In 2020, revenue in the STR space was $9.6 billion, and Statista projects this will grow to $20 billion by 2025.
One reason is the return of normal vacationing following the successful development and rollout of a vaccine against Covid-19. The well-documented pivot away from traditional hotels and toward STR offerings among vacationers has been under way for years.
However, the largest driver of this projected increase in STR revenue is the lifting of constraints of having to live close to an office, driven by an increasing acceptance of working from home. The practice of working remotely started long before the pandemic – when I worked full-time in the Chicago tech industry, I could work from home every Friday, and whenever else I wanted if I notified my manager. I still had to be within a certain radius of my office since I needed to go in most days.
What is gathering steam, however, is the option to be completely remote. A few years ago, my friend in Toronto had one software engineering job offer at a major tech firm and another from a smaller firm that offered him only half the money, but with the option to work 100% remotely. Which did he choose? The one with the smaller paycheck! He so wanted the flexibility to work from anywhere that he was willing to accept half the income. His is only one example, and the pandemic has only accelerated this phenomenon.
My hunch is that many of you want to capitalize on STRs. After all, you can potentially make multiple times the rent than you could on a long-term rental, and if you are saddled with a less-than-desirable tenant, you can look forward to a better one much more quickly. However, be keenly aware that investing in STR comes with its own headaches:
- Finding the right investment. Especially if you are investing remotely, how would you know that you are buying the right property to attract guests and provide them with a comfortable stay?
- Furnishing. With long-term rentals, you expect your tenants to bring their own furniture, but this is not the case with STR. Before you even start marketing to guests, you need to furnish and set up your STR properly. Do you have enough space to enable a comfortable work-from-home experience? Is it laid out in a convenient way? Is it warm and inviting, or does it look and feel cold? Did you provide plates and silverware?
- Communication. You must communicate with your guests before they move in, and often during to ensure a high quality of stay. If you do not respond to your guests quickly enough, they will probably book with somebody else. And while you can say to yourself “on to the next one,” if you do not respond to the next one in time, that next one will book with the next host.
- Cleaning. You must clean the property after your guests move out and before your new guests move in. Sometimes, this could happen on the same day, and if the cleaning is not done in time or to a high enough standard, your ratings, reputation, and future earnings will be negatively impacted.
- Security. You have far less information in screening short-term guests than you will with long-term tenants. It is very easy to let the wrong person into your property, and it takes very little time for the wrong person to wreak havoc on your cherished investment. Make sure you document your property and its contents consistently to mitigate against these potential losses.
- Emergency Response. If something happens during a guest’s stay, who will be there to address the situation? This can be as innocent as the guest losing a key or forgetting an entry code, or as serious as the neighbors calling the police on your guests. When you are working remotely in Hawaii for a month, and you get a call from the police, would you be willing to hop on the first flight to check on your property?
Each of these headaches adds to the logistical nightmare of investing in STR as an out-of-towner, and I mention these particularly because Andes STR, as a turnkey solutions provider, deals with these situations. We handle them so our clients do not have to. Ask yourself, if a company or other boots on the ground did not exist to operate your STR, would you be able to handle things remotely? Realistically, probably not.
I stressed above the importance of finding a great property manager, and it is even more crucial with STR given the increased intensity of maintenance and communication. Other companies, such as Vacasa, also help with operating STR for remote investors. As with long-term rentals, when you are selecting a manager or managing company, make sure to conduct your due diligence – checking online reviews and asking for references is key.
The decision to buy a rental property is one of the largest you can make, given the entrepreneurial outlet and path toward financial freedom this affords you. Investing out of town adds a whole new dimension and headache, in exchange for, hopefully, higher returns. Short-term rentals provide even better returns on top of that, but the complications to get there increase exponentially. Make sure you have the right property manager and partners in place to provide an excellent experience overall. I hope the advice I gave above is a helpful starting point.