Buying Out-of-State Rentals

Interested in real estate but worried you don’t have the funds for where you live? Hear from guest blogger Andrew about his decision to invest in out-of-state real estate.

Editor's Note: Today’s guest post is from Andrew, a New York lawyer who decided to invest in out-of-state real estate without even visiting the property. He blogs at Living Rich Cheaply. Andrew and I have no financial relationship.

I’ve always heard that investing in rental real estate is a great way to build wealth. It is hard to deny the benefits of investing in real estate, with cash flow from rent payments, principal pay down by the tenant, the use of leverage, appreciation of the property as well as rents, and the ability to depreciate the asset. Living in New York City, I thought my real estate investment would be relegated to buying a REIT fund. Housing costs here are prohibitively expensive and even if I could afford a property, would it even cash flow? Of course, I’m not saying real estate investing doesn’t make sense in NYC. I’m sure those who bought properties in up-and-coming neighborhoods in Brooklyn are doing just fine. However, solely relying on appreciation is speculation.

When I read about real estate investors in other parts of the country buying houses for $100,000 and renting them out for $1,000, I was pretty envious. I wish I could invest there, but I’d have to research what neighborhoods make sense for rentals. I’d have to find a realtor, find the property, hire and manage a contractor to get the property rent ready, and manage the property from afar or hire a property manager. For someone with a full-time job and little experience in real estate investing, it was not something I could take on.

Enter turnkey real estate providers

After reading the Biggerpockets blog and forum as well as blogs of people who invested long distance through turnkey providers, I started to think I could also invest in real estate. These providers provide a solution to this common problem to out-of-state investors. Generally, a Turnkey provider buys a property at distressed prices, renovates it, and sells them to investors. They also provide property management: screening and placing a tenant as well as dealing with the day-to-day operations of the property. It is a one-stop shop for your real estate needs. They generally charge about 10% of monthly collected rents to manage the property. While investing in real estate is never truly passive, this is as close as it gets. You check your owner’s dashboard online to see that you got paid and if there were any repairs needed. he property manager contacts you if the repair is above a preset amount.

Turnkey real estate investing sounds like it is too good to be true. While there are many benefits, there are also some things to watch out for.

You are paying a premium

Many experienced real estate investors aren’t fans of buying property from a turnkey provider. They prefer to buy properties at distressed prices, fix them up and then rent them out. With this method, they have much more equity in the property. When you buy a property from a turnkey provider, you are most likely paying market value. There is a reason turnkey providers are selling the house at market value. They did the all the work and took on the initial risk. I don’t necessarily see anything wrong with this business model. However, many out-of-state investors look at these houses in the South or the Midwest sold by turnkey providers and say, “wow, they’re so cheap!” Be careful though, as cheap is relative. Sure, you might think the property priced at $150,000 is cheap but if all the comparable houses sell for $125,000, you’re overpaying. Many times, the turnkey property will be higher priced than many properties in the neighborhood because the turnkey provider has completely renovated it. Paying market value is not necessarily a bad thing, but just come in knowing that fact. If you have to sell soon after buying the property, you’ll likely lose money, unless it has appreciated in value. (Biglaw Investor: Which seems unlikely in most of these markets.)

Location matters

Some turnkey providers seem to sell properties in lower-priced neighborhoods. Maybe it’s because it makes the numbers look good on paper: Buy a $50,000 house that rents for $800! However, sometimes a house is really cheap for a reason. If it’s a really cheap house, it’s possible that it is not a great neighborhood, in which case the prospective tenants might not be financially stable or have other issues. While it’s possible to make money investing there, it might not be the best move for an inexperienced investor who does not live in the area. Furthermore, that type of neighborhood will likely see less appreciation so make sure you do your research.

Run the numbers

Some people have taken the monthly rent and subtracted the monthly mortgage payments (including tax and insurance) and the property management fee and say that’s how much they will cash flow. That may be true for some months, but you better take into account vacancies, repairs, and capital expenditures when you do your calculations because those costs will come up. Run the numbers yourself and don’t just rely on the pro forma statements provided by the turnkey companies. (Biglaw Investor: The numbers I’ve seen have all been pretty “rosy” as well. The pro forma statements are essentially the marketing copy that a turnkey provider will use to sell the property. It doesn’t mean that they’re lying to you since any reputable turnkey company that inflates numbers will soon find itself out of business but you definitely need to run your own numbers. Nobody cares more about your money than you.)

My experience

When I decided I would invest in a rental property out-of-state, I narrowed it down to cities where housing was relatively affordable and where it would cash flow, but also a city where the economy was strong. I contacted turnkey investors to see how their experiences went. Ultimately, I chose a turnkey provided in Kansas City, Missouri. One main reason was because it offered a “hybrid approach” where I would have more equity from the start. The company I worked with first acted as my realtor in bidding on properties, generally foreclosures. Then it acted as a project manager in hiring and managing the contractors in making renovations to the property. I purchased the property at foreclosure for $60,000 and the renovations cost about $11,000. It appraised for $83,000 and a tenant was placed paying $850 a month. The closing took place at the cafeteria of my work place during lunch with a mobile notary. Things are going relatively well but I would say that there have been more repairs than expected which have taken a significant bite out of my monthly cash flow. In 2016, my repair costs totaled $2500 and in 2017, $1400. From what I hear from those who bought a property from a pure turnkey provider, they had much less repairs as with this model, the company supposedly does a complete renovation of the house whereas the route I went, they did repairs to make it rent ready. I am still happy with the investment as I had much more equity going in and it has also appreciated since that time. Then rent has also increased to $895. If it wasn’t for the appreciation, I might not be too happy with this investment and I’m not sure if such strong appreciation can be expected going forward.

This company no longer does this “hybrid approach” as the real estate market there as well as many other places are pretty hot and very competitive. There are still companies which will help you buy a distressed property, renovate it for you, and then manage it for you. However, you will likely have to pay cash and then refinance afterwards.

I still think turnkey real estate investing is a good idea for someone who lives in an area where there is no cash flow, someone who is inexperienced and wants a little more hand-holding, and someone who is too busy to be a landlord. Just make sure you do your due diligence and research before you make your investment. You can always take a more hands-on approach later on but at least get started investing in real estate.

You can read Andrew’s latest real estate update here, including how he’s shifting his strategy to Buffalo.

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money. He’s also maxing out tax-advantaged accounts like 529 Plans to minimize his taxable income.

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    Six thoughts on Buying Out-of-State Rentals

    1. Some thoughts- From his site, Andrew mentions that he made about $1,000 in 2016 and just under $2,000 in 2017 on this property. You can also tell from his total rent collected number that he was fortunate in that he had full occupancy for all of 2016 and 2017. Even one month of non-occupancy (at $895/month) would drastically impact the return. I would suggest that potential investors should really be considering the risk-adjusted return for this type of investment as compared to other investments in real estate.

      With regard to calculating his return, he mentions that he took out both a mortgage and a rehab loan. The mortgage amount is not given, so we don’t know how much cash he has in the property. However, for loans out of foreclosure, they often won’t finance the 80% of value that they will for regular purchases. I am going to ballpark that he has $20K in cash in the property. That gives him a 10%-ish cash-on-cash return when all goes reasonably well. I note that you are probably going to have repairs in the neighborhood of 1% of house value every year – and this does not include an allowance for rental vacancies – so the repair numbers that he bemoans should be expected. His range of yearly cash-on-cash returns can be -50% (if no renter – not likely, but in the range) to +10%. Overall, he seems to be getting OK cash-on-cash returns with a lot of risk.

      As Andrew mentions, where he really lucked out is in the appreciation of the property. In his blog, he mentions that the property he bought in 2015 (72K value – 60K purchase and 12K fix) appraised for $112,000 in 2018. That’s a 55.6% gain in 3 years. That’s ….. virtually unheard of in a midwestern market – we don’t appreciate like San Fran or NY. All real estate is hyper-local, but I note that Andrew’s 55.6% 3-year gain vastly outpaces the 26% 3-year gain reported for Kansas City, MO as a whole.
      Assuming the number is accurate, (and it might be based on the low price out of foreclosure) it seems like Andrew got extremely lucky with regard to his appreciation – but that kind of appreciation will not continue. This also illustrates why many investors will focus on buying out of foreclosure, fixing up, and then selling – because that’s pretty much where the big money is being made in Andrew’s project, not in the renting.

      A couple of other items to note, Andrew mentions that he has taken an additional $24K
      out of the property – so his mortgage amount has increased. Assuming a 5% interest rate (investors have to pay higher rates than occupants), that increases the mortgage cost by $1,200/year. This does not take into account a likely increase in real estate taxes based on the increase in value of the house. Note that this will further depress his cash-on-cash rate of return for the house – he was only making $1-2K/year when things went well. It also greatly increases his risk that he will have to put further cash into the property if his rosy rental conditions do not continue. It looks like if he has even a single month with no tenant, then he is out of pocket.

      People thinking of projects like this would likely be well-served to consider the risks. Here’s an interesting initial article about why real estate investors fail.

      1. Great in-depth analysis. While you made some valid points and people who are considering this type of investment should definitely consider the risks, I do still have confidence in this type of investment.

        As to the repairs, it is an expense that should be accounted for and I did. Some would say to estimate 1% of the property price, others estimate 5 to 10% of the annual rent. In any event, repairs are to be expected but I think my first year expenses far surpassed those estimated amounts due to a unexpected repair that is unlikely to reoccur. Google chose KCMO as the first city to receive Google Fiber. While one of it’s 3rd party contractors was laying the fiber optics, it hit a sewer line on my property. They paid for the repair, but I was still out about $700 for initial diagnostic and repair. Sure, I could have tried to take them to small claims court, but it wasn’t worth my time, especially since I am out-of-state. There were some other repairs that may have been avoided if I had spent more initially.

        With regard to appreciation, you’re right that I lucked out, but I’m not sure I agree with your numbers. The property appraised for $83,000 after the renovations, so I don’t think it would be entirely accurate to use the $72,000 purchase price to determine the 3-year gain. The $72,000 to $83,000 gain would be “forced appreciation” due to the work done and the $83,000 to $112,000 would be natural/market appreciation. That would make it a 34.9% over 3 years which is higher than the average, but not “vastly.” Also, while betting on appreciation involves a lot of speculation, I think an informed investor should be able to target a neighborhood where the appreciation slightly outpaces the average.

        As to property taxes, there hasn’t been a significant increase. I am not exactly sure how the county there assesses the property and determines the taxes though. However, you haven’t taken into account the likely increase in the amount of rent overtime. The previous tenant left after their lease ended and the new tenants now pay $1050. There was no vacancy in between tenants. You can call that luck or you can call that buying in the right area…probably a little of both. (There are, however, costs associated with the transition though…lease up fees/repairs)

        Another thing you didn’t account for is the mortgage pay down. Finally, with other real estate investments you mentioned, it’s unlikely you would have the tax advantages of a direct investment in a rental property.

        1. Hi Andrew! Thanks for providing more information and discussion – and you have some great points! You have my best wishes for continued good fortune!

        2. Hi Andrew, glad to read that your investment is going well. I’m also considering KS. May I ask what part of town it’s in? Thanks!

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