Summary: This is part one of a three part series for finding and establishing an out-of-state area for real estate investing. In part one, we provide a step-by-step guide for choosing a city/location. In parts two and three, we will cover building a local team and managing your real estate rentals from afar.

 

Finding attractive deals and building a competent real estate investing team in your home market can be a challenge. But imagine trying to do that remotely or in a city that you’ve never even visited. The complexity goes up several fold.

Why should you consider out-of-state investing?

Many don’t have a choice because they live in a place with inflated prices and high cost of living. It’s nearly impossible to find properties that cashflow in cities like Honolulu, San Francisco or New York, for example.

Others are located in markets with intense competition, often driven by the entry of investment companies or professional investors.

Still others live in an area at high risk for natural or man-made disasters, like earthquakes, wildfires or flooding. In our case, for example, the high risk of earthquakes associated with the Cascadia fault line was one of the driving forces that led to look for properties in other areas.

Finally, others who already own a substantial real estate portfolio in their home area may be worried about their lack of market diversification.

If you find yourself in any of these situations, you should consider out-of-state or remote investing.

When we first started out, Kenji and I were primarily investing north and south of Seattle. In the last couple of years, however, we’ve had to branch out and establish teams in other markets to find good deals. These include cities in Washington, Colorado, Indiana, Oklahoma, Tennessee, Texas, Massachusetts, Pennsylvania, Texas and Georgia. This guide is drawn from our experiences with setting up out-of-state networks to create a robust funnel of deals. 

 

Where to Start

As this guide will outline, there are a lot of considerations that go into selecting a site for out-of-state investing, and this is even before you proceed to some of the more difficult steps such as building your team of competent agents, property managers and contractors. This is to say, the process can prove to be labor intensive and overwhelming, especially if you are new to real estate investing.

But remember, the most important thing with real estate investing is: the sooner you start, the sooner you can take advantage of compounding growth, and the better off you will be one year, five years and ten years down the road.

Therefore, for those new to real estate investing, we suggest that rather than getting bogged down with the details provided, you consider piggybacking on someone else who is already successfully investing in an area so you can start building your portfolio immediately.

Piggybacking on someone else’s market knowledge is helpful because you know your contact has probably vetted the area well and has already found neighborhoods where investments are cashflowing. It also gets you investing faster rather than being derailed by indecision or analysis paralysis.

There is no shame in piggybacking: we have piggybacked on others, and we’ve also helped many our friends piggyback on the teams we’ve put together in Spokane and other areas. And we are happy to continue to do this for others as we broaden our knowledge and investment experiences in different parts of the country.

Part of our goal in creating the Semi-Retired MD community, in fact, is that we will all be able to piggyback on each other’s expertise in different markets across the country as the group expands over time.

While there are many benefits to piggybacking, we’d still recommend putting in some time to learn about the market and forging your own contacts and knowledge to supplement those already in place. Markets change over time, so it’s important for you to be able to “read” the shifts so you can adjust accordingly. Moreover, you may find that you forge superior contacts to those already in place as you gain experience in a particular market.

Therefore, we offer this guide to be used as a supplement to piggybacking so that you can be well-informed of the steps involved in establishing a new area.

 

Identify the Location/City

Choosing a city (or cities) where you want to invest is one of the more difficult parts of the process. This is because there are unlimited options, and it is sometimes difficult to determine based only on online research why one city is better than another without having a “feel” of the place. 

The good news is you can explore multiple cities at a time. The bad news is that doing that takes a multiplier of your time and energy – looking at deals, reaching out to and juggling agents and property managers and construction teams takes a lot of time and effort on a weekly basis, not to mention the costs if you decide to visit each city to see them in person.

Therefore, our advice is to focus on 1-2 cities initially and branch out to others depending on your time and finances.

 

Familiarity with the area

When we are searching for a new city for real estate investment, one of the first things we consider is our familiarity with the area.

For example, Kenji grew up near Philadelphia. I went to medical school in Burlington, VT. Both of our experiences with actually living in a city help guide where we look at properties. This is because we have some sense of the “good” areas of town and some of the main bedrocks of the region (University of Vermont, for example). We are also sometimes more familiar with local happenings like new companies moving into the region or areas of future development (i.e. where is Amazon or Boeing going next?).

Clearly the longer you have been away from a city, the more out of date and less useful your past experiences will be in helping you make choices in the current market. In the event that you do not have personal familiarity with a city, remember, you can sometimes lean on your friends or acquaintances for insights.

 

Price to rent ratio

The price to rent ratio is a simple equation (Purchase Price divided by Annual Rent), which helps differentiate cities that are less attractive for owning rentals (high ratio) versus more attractive areas (low ratio).

An easy example from our experience is Hawaii, where we currently reside. In our neighborhood $1.4 million dollar properties are renting in the $4,000 to $5,000 a month range. This gives you a price to rent ratio of approximately 26 ($1.4 million divided by $4,500 x 12). In comparison, we have a duplex in Spokane currently renting for $2,400 a month, which we previously purchased for $160,000 (price to rent ratio of 5.5). This is an extreme example, but it gives you a sense of how how one area can stand head and shoulders above another in attractiveness to an investor.

Zillow, Redfin and Trulia are great resources for determining the price to rent ratio. This will allow you to fairly quickly identify areas where it just doesn’t make sense to invest. Also check out this Bigger Pockets article for recent data on cities with low price to rent ratios.

 

State Income Tax, Sales Taxes and Property Taxes

Taxes eat into your profit significantly, so it’s good to be able exclude areas with high state income tax, sales taxes or property taxes early on in your search.

Most of our rental properties are located in Washington State. Why? In part because we have familiarity with the state, but the other big reason is the lack of state income tax. Washington is one of seven states with no state income tax. The others are Alaska, Florida, Nevada, South Dakota, Texas and Wyoming.

Currently we are looking into purchasing properties in Tennessee vs. Georgia. While GA has an income tax of 6%, TN only charges income tax on dividends and interest. However, GA sales taxes are lower. So this tells us that, for the long term, if we find an equivalent property, it makes more sense to invest in TN over GA. That being said, if our property requires a lot of renovation when we first purchase it, our costs will be lower in GA.

The Tax Foundation is a great resource for comparing state tax income and sales tax rates.

In this example, though, we are comparing two equivalent deals in TN vs GA. The reality may be that we find a better deal in GA rather than TN. If that’s the case, the better plan is clearly to buy the property with overall superior cashflow.

Finally, property taxes can vary dramatically from town to town and region to region within a state. Once you have a location/city identified, it is useful to use Redfin or another real estate site to compare the cost of property tax from one area to another. For example, we were considering investing in Kenji’s hometown outside of Philadelphia, PA. Once we saw that property taxes for investment properties in certain suburbs ran between 3-4 months of the rents being collected, we were able to quickly move on to focusing on deals in other areas. When you are paying the equivalent of 3 month’s rent for property taxes, the chances of finding a property that cashflows decently greatly reduces.

 

Current population size and job growth

These factors are perhaps fairly intuitive, but still warrant mentioning.

The size of the city where you invest can have implications for the level of risk. If you choose to invest in a small city with only ten thousand people, for example, this could mean additional risks if a business moves out of town or a store closes and lays off workers. On the other hand, a large city with millions of inhabitants may have less population flux, but will have more competition when it comes to renting your place out.

The size of the city where you should invest, then, is tied to your personal risk tolerance and whether or not you believe in the location’s future growth. We like to invest in the areas surrounding large cities (better cashflow in surrounding areas than downtown) and avoid investing in small towns as we are more risk averse. We are also planning to hold onto our properties for 20+ years, so we value stability in an area more than rapid growth.

Regional job growth is another important factor to weigh before deciding on an investing location. If a city’s population has been declining for the last several years because of job losses, it’s probably not a good choice. If the rumor is that Boeing is moving out state, the area near the factory may not be so attractive to renters 5 years from now. Another example we recently encountered was a county in financial trouble because it had committed to financing a new sports stadium. Any cost overruns could lead to higher property taxes to cover the shortfall. All of these types of market changes can have effects on you as a property owner.

Ultimately, population and job growth are some of the more significant factors that play into rent appreciation and property appreciation. Although we do not advise real estate investing primarily for these benefits (we consider appreciation plays to be a form of gambling), it’s always an added benefit to have a property’s rent increase each year and to be able to sell it down the road at a significant gain.

Check out Forbes’ picks for where to invest in 2018 for ideas.

 

Natural disasters

This is an important one. For us, the risk of an earthquake due to the Cascadia fault line was actually one of the main factors that led us to consider investing in new markets like Spokane. In the event of a large earthquake, we didn’t want all of our properties to be located near Seattle and damaged and/or vacant all at one time.

A similar argument could be made for investing in parts of California (wildfire risk) or Oklahoma City (risk of earthquakes caused by fracking) or Florida (risk of hurricanes). This is not to say you don’t invest in that area, since most cities have some risk of natural or man-made disaster. It just means you should take this into consideration when investing in an area with a specific natural disaster risk and seriously consider spreading your properties across multiple geographic regions for diversification purposes.

 

Cost of LLC creation/transfer of property (aka documentary stamp taxes)

We have chosen to shelter all of our properties in LLCs as part of our asset protection strategy, which we’ll cover in detail in a future post. If you choose to shelter your properties in LLCs, it will be important to consider the varying costs of setting up an LLC in each state.

So how are LLC fees different?

First of all, the cost of LLC set up and yearly fees can vary greatly from state to state. For example, LLC start up fees currently range from $50-500 per state.

In addition, and this is the important one, there can be additional costs besides the LLC set up/maintenance fees. For example, Florida has something called a documentary stamp tax, which is a fee you pay for transferring interest in real estate. This includes transferring a property from your name into a LLC. Transfer of a million dollar property to a LLC costs $0.70 per $100 dollars or >$5,000 in most counties.

If you think you want to form an LLC for asset protection and tax benefits, consider researching the start up and yearly fees and be sure to check if there are other fees prior to choosing to invest in a particular state/city.

 

Now that you’ve chosen a city….

Now that you’ve chosen a city or two where you may want to invest, spend time looking at properties online using free sites such as Trulia, Redfin and Zillow (and Zillow Rentals). Check out properties in different parts of the city to build knowledge of specific neighborhoods. Read the local newspapers. Talk to friends and acquaintances who have more familiarity with the city than you do. Make sure you build some level of base knowledge while you start to work on the next step, Defining Your Criteria.

Questions? Feel free to reach out to us by email or through our facebook community.