Residential real estate investing, particularly in single-family homes, has very recently shifted from a local proposition to one without geographic limitations. New developments in technology, financing, services and processes make it easy for investors to search for investment opportunities, purchase properties and manage them from afar in a way that wasn’t possible just a few years ago.
The fundamentals for successful home investing apply whether a property is next door or on the other side of the country, as a thorough amount of due diligence when evaluating an investment can make all the difference between achieving a return and dealing with a money losing headache.
By focusing on five key areas, investors can improve the likelihood of hitting ROI goals and minimizing hassle.
Understand the total costs:
Low prices or high gross yields relative to an investor’s home market can lead to quick purchases, but any number of line-item costs in one location can be substantially different in another. Taxes can vary greatly, and easily consume the yield an income-focused investor may be chasing.
Property management fees can also catch investors off guard, especially because they are higher in less populated areas that have little scalability or no competition. Midwestern investors might not factor in hurricane or earthquake insurance when investing on either coast, which can be expensive. Those far from water may underestimate flood insurance in those markets.
Investors often look for turnkey properties, which can make condos appealing when first entering a new market. However, monthly HOA fees can severely suppress yield and additional HOA assessments could put the property in the red at a moment’s notice.
Choose your tenants wisely:
Most investors that aren’t local to a property will use a property manager to identify and qualify tenants. Investors still need to be very engaged, detailing exactly what criteria and standards they require.
The common metrics are a certain FICO score, no bankruptcy in the last few years and an understanding of rent-to-income. This last one can be especially tricky because some markets have a much higher percentage of income going to housing.
Local property managers will be able to help with guidance. That said, the minimum income ratio is almost always two and a half times the rental payment.
On the more qualitative side, landlord references are important. Collection loss is a line-item cost you want to minimize as much as possible and by speaking to a potential tenant’s previous landlord, you can gain a certain level of comfort on the tenant’s payment habits.
As a final consideration, investors need to understand local laws about tenant selection and advertising for tenants. An investor may be seeking a young, married couple with no kids, but there are laws in place to prevent discriminatory housing practices.
Know the market as if you live there:
Market research has never been easier, so there are no excuses. Talk to local brokers, read the online version of the local newspaper to understand what is happening in the economy and even visit the area if you’re serious. Identify the drivers behind the current housing market and know the historical context.
For example, California’s desirable areas are unlikely to ever be low-priced, but tend to appreciate more consistently than most markets. In Texas, the pro-business government policies that have come into place are bringing companies and jobs (and thus, a need for more housing).
A healthy educated workforce is a good indicator of long-term price appreciation, which both of these markets have benefited from in recent years. Alternatively, lower home ownership rates that are common in some Midwestern areas like Cleveland and Indianapolis can consistently produce strong yields, although meaningful property appreciation is very unlikely.
Choose either appreciation or yield or go for a little of both:
Deciding which type of market you want will help with focus. Most investors have one strategy and branch out to markets where they can stick with it, but diversifying can also be a reason to look beyond local opportunities.
Independent of strategy, it is important to look further back than the past couple of years – as far back as 30 or 40 years, in fact – to understand the likelihood that the new market will consistently deliver against a particular investment approach.
That said, there are some markets that straddle yield and appreciation, and researching the long-term trend for market dynamics is especially important as these markets may quickly shift to only yield or appreciation.
Know your exit strategy:
This is one of the biggest differences between a consumer homebuyer and an investor. Consumers need the home to live in, and are less focused on exit strategy. Investors should have an investment strategy in place before pursuing properties.
Whether an appreciation or yield investor, the number of owner-occupied houses is important because a higher rate of home ownership likely makes it easier to sell the home to a consumer rather than having to find another investor or if all else fails, being left with passing down the property to heirs.
The overall liquidity of the market is also important. Is transaction volume high, especially relative to listings? In rental-heavy markets, transactions aren’t a strong metric, but thankfully data now exists to help investors understand the vibrancy of a market even if there isn’t much buying and selling.
The rule of an opportunity being “too good to be true” is particularly applicable in long distance real estate investment purchases. Information gathering is critical, and fortunately much of that can be done remotely.
Using the data analytics and services available today have helped residential real estate investing evolve from driving around neighborhoods and using intuition to surfing locations online and making fact-based decisions.