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Choosing the Best Out-of-State Market

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There are many debates in the world of real estate investment. Multifamily versus single-family. Residential versus commercial. Flip versus buy-and-hold. Of course, one of the most enduring—and contentious—debates in the industry is that of local versus remote real estate investing.

You might be surprised to learn that a majority of real estate investors are, in fact, out-of-state investors. With the advent of the internet and investors’ ability to see and buy property anywhere, out-of-state investing has grown in popularity.

Conventional wisdom may say to invest where you are, presumably so you can better control outcomes. Modern sensibilities, however, tell us that investing beyond our local markets can be more beneficial to the health of a buy-and-hold real estate portfolio.

Related: Why Your Home Market May Not Be the Best Place to Invest

Two main reasons to invest out of state

1. Portfolio diversification

The number one advantage to out-of-state real estate investing is portfolio diversification, pure and simple. Diversification happens on two distinct levels: how many properties you have and where those properties are. Owning more than one investment property helps you manage the risks that come from vacancies or individual property expenses. Multiple investments can sustain your returns in the meantime. On a higher level, buying across multiple neighborhoods and markets continues to hedge against risk.

The economic factors that shape each market will shift and vary. Demand will ebb and flow. Natural disasters are a possibility. When you own properties in various markets, you can avoid taking a hit to your whole portfolio because of one hurricane, one legislative move, or one economic downturn. While these things rarely ruin a portfolio, they can put a damper on your returns and your forward momentum.

2. Affordability

Besides the advantage of diversification, affordability plays a key role in why investors choose to go beyond their local markets. The United States is vast and varied. You’ll find that your dollar will go much farther in a southern suburban market than in an urban coastal hub. If you invest in, say, Alabama, rather than in San Francisco, you’ll find yourself able to afford five properties for the cost of one.

Being able to more quickly scale your portfolio means more diversification, less risk, and a better rate of return. Your price-to-rent ratios will look a lot better in more affordable markets.

Of course, investing out-of-state is more complicated than that. Despite the clear advantages, investors can make a big mistake going into the wrong markets unprepared.

5 key qualities in an out-of-state market

1. Relative affordability

Relative affordability is something we’ve already talked about in terms of advantages. However, it’s also a quality to look for. Investing out-of-state isn’t enough—the numbers have to check out. The biggest danger here is falling prey to the lure of “hot” markets.  Prices will push up, hurting your price-to-rent ratio and, ultimately, your cash flow potential.

This is why it’s important to pay attention to a market’s performance in terms of list prices versus sales prices. It’s why appraisals and inspections matter. For the real estate investor, you want to capitalize on the relative affordability offered by an out-of-state market. If you only target “hot” markets—often those with rapidly growing property values—you run the risk of a future crash.

Beware of overpaying, even if the market is, on the surface, more affordable than your local market. You still want to ensure that you’re paying for quality and a solid long-term investment, not just hype.

When considering relative affordability, consider the relationship between supply and demand, the potential for housing bubbles, and what you’re getting for your money.

2. Long-term stability

No one said buy-and-hold investing was exciting. Rewarding, yes. Thrilling? Not necessarily. When investing out of state, more stable markets are where you want to put your money. While the fast and furious environment in a highly competitive market is exciting, you’ll likely end up overpaying—not to mention the desire to “win” may cloud your judgment.

Stability is the key here. While you want to target markets that see an upward trajectory in their performance (which we’ll cover momentarily), they don’t have to be among the fastest-growing, hottest markets in the nation to make for a solid investment. Ideally, your out-of-state market will provide you with appreciating property values, increasing rental demand, low vacancy rates, and long-term residents.

When a market is more stable, residents are more likely to settle in for the long haul. Because affordability (both in terms of housing and a general cost of living) is increasingly an issue for Americans, this sense of stability is particularly important.

A rapidly evolving market may be attractive for its energy and excitement, but it may not be the best solution for investing when you intend to hold onto your properties for five or 10 years or more.

3. Investor interest

While the hottest markets can be a double-edged sword for real estate investors, overall investor interest does matter when it comes to your market choices. This is why, for the real estate investor, networking is key.

What are other investors doing? What areas are they interested in? Why? What’s their record of success?

Listen to other investors—you might find market opportunities that were never on your radar before. This is especially true when you consider real estate investing veterans. At the same time, remember to evaluate other investors relative to you. What may be a great investment for someone who has more experience, higher risk tolerance, and more resources may not be so great for a new investor with limited diversification and experience.

With that said, pay attention to where the investors are going. Oftentimes, you will find that they move ahead of larger trends and capitalize on the positive markets to watch

4. Positive economic indicators

When evaluating any market for investing, the numbers are what really matters. You can feel an affinity for a market, hear the hype, and see the success of others, but think twice if the numbers don’t check out. Every real estate market is connected to the broader economic market of the city or metro. The economy absolutely drives the health of the real estate market.

For real estate investors, your numbers aren’t limited to price-to-rent ratios, cash flow calculations, and cap rates. These are all important, but there are numbers beyond your individual investment that guide long-term success.

Some of these indicators are:

Job growth

Job opportunities drive population growth. Population growth creates real estate demand. When considering the local economy, investors want to look at job growth, unemployment rates, median salaries, and similar statistics. If the job market is suffering, the real estate market will follow.

It also offers more insight into your residents: what they can (typically) afford in terms of their rental, what is sustainable for the long-term, and the likelihood of retaining long-term rental residents.

Industry diversification

Houston, Texas, is a prime example of why industry diversification matters in real estate investment. In the 1980s, an oil crash was absolutely devastating to Houston’s economy. It was the crash to which all other crashes are compared. Many Houston banks were on the verge of closing. Real estate collapsed due to overbuilding.

In the past several years, we’ve seen other oil crashes. Some of which compared to the dismal drop in the 1980s. However, we have not seen the same level of devastation in Houston that one would expect given the past. In fact, many otherwise significant crashes in the oil and gas industry haven’t caused Houston to miss a beat.

This is because, in the years since the ’80s crash, the market diversified. Rather than heavily relying on oil, oil is just one of many crucial industries that support the market and its job opportunities. Because of this, dips in the oil industry have a smaller impact on the economy at large. It’s simple diversification.

Population growth

Is your market growing? An increase in population over years, even decades, is a positive indicator for real estate investors. Population growth is naturally tied to job opportunities and the health of the local economy.

Pay attention to these trends, as increasing real estate demand makes for smaller vacancy periods. Not only that, but population growth is a sign that a market is where people want to be. Whether it’s for good jobs, a good cost of living, or a favorable family environment, population growth means you’re more likely to find an abundance of would-be residents, especially those in it for the long haul.

Cost of living

Debate about whether or not we’re currently in a housing bubble rages. Regardless, we do know that we’re in the middle of a new economic recession thanks to the COVID-19 pandemic and its economic fallout. Remember, real estate is intrinsically tied to the economy.

While we’ve seen 2020 real estate defy all expectations, it cannot totally escape the economic impact we’ve seen this year and that which is yet to come. Experts have argued that we’re amid the Great Affordability Crisis, a theory presented well before the pandemic was fully known to the United States and plunging us into recession. Healthcare and housing costs are two major issues pushing American families to the brink.

Because costs across the board are outpacing wage growth, it only makes sense that Americans are struggling to make ends meet. This is why targeting affordability, not just in terms of property acquisition but in terms of living in a market, matters for investors. The more unaffordable a market becomes, the fewer people can afford to stay long-term. It’s simply not sustainable. With that said, the cost of living compared to wage growth is more favorable in some markets than others. It’s a metric that real estate investors would do well to pay attention to.

Median home values

While the indicators thus far have been more related to the economy than to real estate, home values matter, too. Real estate investors—particularly buy-and-hold investors—benefit from their investment in more ways than they realize. Cash flow is only a part of the equation. Median home values and their trends over time can help investors know what to expect in terms of property appreciation.

5. A support structure

As important as a market’s economy, affordability, and stability are, they pale in comparison to an investor’s support structure. Your numbers can check out. The investment can really and truly be solid. You can have all of the pieces in place. But if you don’t have the proper support system, you can still fail.

Out-of-state investors cannot neglect this. They, even more than local investors, need to have a quality, reliable team in place for property management and maintenance. You need a team that can address resident concerns and property issues swiftly and empathetically. So many real estate investors compromise on management in the hopes that it will save them money and make their cash flow look better.

While on paper it may be that way, you suffer without the right structure.

Related: Investing Out of State? How to Find a Rock Star Agent in a New Market

Hiring the right team

An experienced, diligent team of professionals that can help you identify the right properties (at the right prices), invest in the right markets, and manage the properties you have is priceless. This support structure is more than just a management team.

Many out-of-state investors choose to go with a turnkey company. Even then, a turnkey company—people who should help you preserve your capital through diligent advice, maintenance, and management—can further your support structure by connecting with trusted lenders and local vendors. This ensures that you’re getting the best financing and the best job done on behalf of your property.

At least, that’s how it should be.

Before you invest out of state and start looking at numbers and market indicators, look for the right partner to turn your investments into long-term, lasting wealth.

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