About the author: G. Brian Davis is a real estate investor who has owned dozens of investment properties over the last 15 years. He’s also the co-founder of SparkRental.com, an online resource which provides free landlord education and video series for anyone looking to build passive income from rentals.
Are U.S. real estate markets overpriced, undervalued, or just right?
It turns out they run the gamut. No matter what else you can say about U.S. real estate markets, they’re indisputably uneven. The median home price in Indianapolis is $125,000. In San Jose, CA, it’s nearly ten times that number at $1,100,000.
Sure, differences in local incomes can account for part of that spread. But not all of it, or even most of it; San Jose’s median income is $117,474, which is not even double that of Indianapolis’s median income.
In many coastal cities, home prices are so high compared to local incomes that it’s hard to justify investing in real estate there. This says nothing of the fact that many investors couldn’t afford to buy property in these cities, even if they wanted.
Enter: the rise of long-distance real estate investing.
Why out-of-state real estate investing
One reason, as outlined above, is that some investors in high-cost cities simply can’t afford to buy properties there. So, they’ve increasingly been looking further afield and buying an investment property in another state.
But it’s not the only reason.
Overpriced coastal cities tend to offer poor returns to real estate investors.
To continue the example above, consider Santa Clara County, home to San Jose, CA. According to Attom Data, the annual gross yield for single-family rental properties in Santa Clara County is 3.6%. Meanwhile, Indianapolis’ Marion County boasted average rental yields of 11.6%—returns over three times higher.
It’s not hard to see why investors living in San Jose find markets like Indianapolis enticing.
Greater room for appreciation
When the ratio between local incomes and home prices becomes too high, there’s little room for home prices to rise further without significant income growth.
Historically, this ratio sits between 2.5-4 in a healthy real estate market. But as the Bookings Institute points out, some cities have median home prices over ten times higher than median incomes. It’s simply not affordable or sustainable for these cities to see much more appreciation without higher incomes.
The first rule of mitigating risk in investing is diversification. And buying a house out of state is one way to diversify your real estate portfolio.
After all, if you only invest in your home market, and that market crashes (think Las Vegas in 2008), you’re in a lot of trouble.
If you live in a state or city with laws unfriendly to real estate investors, it often pays to invest elsewhere.
For example, the laws in my home town of Baltimore tilt entirely toward tenants. Landlords not only have several different bureaucracies to register their rental properties with (and pay fees to), but properties must be inspected regularly, and those inspections must be filed with the city government. Legal protections for tenants abound while it takes upwards of six months to evict a bad tenant.
Or take New York City’s restrictions on Airbnb usage, barring all units where the host doesn’t live themselves. Not exactly a prime place to invest in a short-term vacation rental property!
You can find overviews of real estate laws by state at FindLaw.com.
Risks of long-distance real estate investing
Buying a house in another state is not without its risks and downsides. The most obvious is that it’s not always possible to see properties with your own eyes before buying, which comes with its own set of challenges.
Inaccurate valuation numbers
When you’ve never visited a property, much less its surrounding neighborhood and comps, it can be difficult to know the value.
Sure, you can look at photos of the property, and those of nearby comps. But photos don’t tell the whole story; you can’t smell mold through photos, or feel the building shake when an underground train passes every ten minutes. It’s hard to determine a home’s value based on photos and maps alone.
There’s a greater risk of missing the mark when determining both the as-is value and the after-repair value (ARV), when you can’t actually visit the property yourself.
Inaccurate repair costs
Similarly, without seeing a property with your own eyes, it’s hard to accurately determine renovation costs.
Photos help of course, and you can lean on a local Realtor’s opinion and get several quotes. But it’s hard to feel confident in the repair costs when you haven’t seen the property’s condition for yourself.
It’s a risk that’s compounded when you hire unfamiliar contractors that you’ve never used before.
Scams and untrustworthy local agents
Buying an investment property in another state leaves you dependent on others to serve as your local eyes and ears.
When the Realtor tells you about the condition of the master bathroom, and how it compares to local homebuyers’ or tenants’ expectations, you have to be able to trust their word. You can (and should) ask for second opinions, and make the most of a thorough home inspection. But ultimately you need to operate based on trust when buying a house in another state.
Contractors can overcharge you and property managers can neglect your rental properties. If you don’t have a local team that you can trust implicitly, you’re at grave risk for people taking advantage of your distance and inability to verify their work.
With the above advantages and risks in mind, what does it take to do it right? What do property investors need to know before buying a house out of state?
Choose the right market for you
Most new real estate investors simply invest in their home market and don’t give much thought to other cities or states. But when you open yourself to out-of-state real estate investing, you suddenly have thousands of towns to choose from. Where do you start?
Start with cities and towns you already know. These could be towns you grew up visiting, or where you went to college, or where you travel frequently for work. Or, if you love vacationing in a certain area, that can make a convenient place to invest, and you may be able to write off some future travel expenses as business-related.
The ideal market depends in part on what kind of investing you’d like to do. For example, if you’re investing in rental properties, state and local landlord-tenant laws should play a role in your decision, as should local price-to-rent ratios. See the interactive map of the U.S., in this Attom Data report, showing county-level rental yield returns, which can provide some ideas for high-ROI rental markets.
But if you’re flipping houses, those are non-factors. A more important factor for you is which direction home prices are trending. The last position you want to find yourself in is buying and renovating a house based on one After Repair Value (ARV), only to find that in the six months it took you to renovate the property, the ARV dropped by $30,000. What was initially a profitable deal could suddenly lose you money.
Check Zillow’s home value index to verify that a local market is trending upward, rather than drooping.
Whether you’re flipping houses or investing in rentals, one factor you should consider is affordability. It doesn’t matter what the potential returns are if you can’t afford to buy a house in that region! But that knife cuts both ways; avoid town or neighborhoods with extremely low incomes, high vacancy rates, and high crime rates. These indicators add risk, and make it harder to sell or rent investment properties.
Choose the right Realtor
The fundamentals of how to choose the right Realtor don’t differ when buying an investment property in another state.
One area you should pay extra attention to is their experience working with investors. You’ll be leaning on their expertise and their eye when they walk through prospective properties. Realtors who have plenty of experience with investors and investment properties will know what to look for—and the red flags to avoid.
Ask these questions before hiring a Realtor, and ideally get as many referrals as you can from other local real estate investors to help you choose the perfect local Realtor. The right Realtor will have connections to many local contractors, home inspectors, title companies, and other investors, all of which will make out-of-state real estate investing easier.
Network to find investment properties in an unfamiliar market
Realtors can help you scout deals listed on the MLS. But if you want to buy off-market properties while having a Realtor represent you, be prepared to pay their commission yourself. Sellers normally pay the buyer’s agent commission for properties listed on the MLS, but for properties not listed on the MLS, you’ll be on the hook for it yourself.
Start networking with local players in the real estate industry. No matter where you’re investing, networking is critical to real estate investing, and the importance of it doubles when you’re operating in an unfamiliar market.
If you’re looking for homes that need renovation (whether as a flip or rental), one group to connect with is local wholesalers. Wholesalers find bargain properties in need of renovation and sell the contract rights to investors. Just make sure you have someone local representing your interests in the deal, such as a Realtor, to walk through the property, scrutinize the needed repairs, and offer unbiased opinions on value.
If you’re looking for a rental property that’s either already rented or ready to rent, network with local turnkey sellers. Alternatively, you can use a turnkey rental property platform to find deals—check out Roofstock, the largest turnkey platform in the U.S.
Lastly, network with as many other local investors as you can. Investors pass deals to each other all the time, and the more local investors you know, the more likely you are to hear about deal opportunities. Try these techniques to find deals on investment properties, no matter your distance from them.
Choose the right contractors
Hiring trustworthy contractors is twice as important in long-distance real estate investing—and twice as hard.
Lean on your Realtor for referrals to trustworthy, reliable local contractors. Also ask around among other local real estate investors. Most of all, follow these best practices for hiring and working with contractors and have your local agent keep a consistent watch on their work.
Verify all licenses, bonds, and referrals before hiring. If the worst happens and you find yourself dealing with a bad contractor, you’ll have more options at your disposal if the contractor is licensed and bonded.
Open local business accounts
While you may not be obliged to file an in-state LLC to own real estate in a state where you’re not a resident, you may decide for tax or asset protection reasons that you want to create an LLC to hold your investment properties. Fortunately, it’s not difficult to do and in many cases, can be done online. Your Realtor should also be able to assist you.
You will, however, need an in-state resident agent if you file an LLC. A quick Google search will reveal plenty of options for resident agent services in all 50 states.
While you can open a business bank account for your real estate investments in that state, you’ll probably find it more convenient to simply open the account in your home state instead. Before deciding whether to create a local LLC or bank account, talk to your Realtor, or an attorney, familiar with asset protection for real estate investors.
More out-of-state real estate investing options
Before buying a house out of state, make sure you know how you plan to finance it. LendingHome offers fix-and-flip loans in 26 states, and you can also ask for local lender referrals from your Realtor.
Keep in mind that flipping houses and buying rental properties aren’t the only options on the table for long-distance real estate investing. Alternatives include REITs, real estate syndications, private notes, and other ways to invest in real estate, even at a distance.
The fundamentals of out-of-state real estate investing are the same as buying locally. The greatest differences lie in trust, and in learning to delegate work to others on your behalf. Screen your local agents carefully, particularly your Realtor and contractors, and you’ll find that the benefits of out-of-state real estate investing outweigh the risks.
Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. Please consult your tax advisor. All calculations and information shown here are for illustrative purposes only. All third parties listed above are for demonstration purposes only and are not affiliated with LendingHome. All views and opinions expressed in this post are the author’s own. NMLS ID: 1125207 Terms, Privacy & Disclosures. Copyright LendingHome Corporation 2019.