“Live where you want, invest where it makes sense” – sounds familiar? I’m a huge believer in investing in multifamily properties, for a variety of reasons, and I currently own over 2,000 units across the country. There’s a high demand for rental units, as more and more Millennials are choosing to rent instead of own a single-family home. In fact, home ownership is significantly dropping in all age groups, while apartment vacancy rates are falling.
Multifamily properties are easy to finance, with many agency loans available at attractive low rates. Owning a property with 1 unit versus 100 allows you to scale and save on expenses. Finally, there are tremendous tax benefits that allow you to lower your taxable income through depreciation.
Why Invest in Out-of-State Properties?
Most people think that since I’m based in California, I’m investing out of state because California real estate prices are too expensive. That’s not the reason! It’s all because of rent control, which is becoming more pervasive in California.
Rent control allows government to place limits on how much landlords are able to raise rents on existing tenants, instead of allowing supply and demand to dictate rental rates. While it does make housing more affordable for some groups and keeps tenants in place, it reduces the number of available units. It also prevents landlords who have paid more for their buildings from collecting increased rents, which means they might not be able to afford regular maintenance and repairs.
In this article I will lay out the 5 steps I used to invest in out-of-state multifamily properties.
Step #1: Choosing the Right Market
Investing in out of state markets requires several key steps in order to be successful, and the first step is choosing the right market, which means a strong market. There are several indicators to look for, including population growth, job growth and rent growth. You want to invest in a market that has positive appreciation on the investments, and you also want a landlord-friendly state.
A landlord-friendly state means that there is positive regulation in place, one that isn’t adversarial to multifamily property owners. That means landlords are free to raise rents when the opportunity presents itself, and there are laws in place to make eviction of non-paying or troublesome tenants easy to evict. In addition, security deposits can be unlimited, and can be returned up to 30-days after a tenant moves out.
How to find information?
To find information about eviction, Google: “How to evict a non-paying tenant.” Thanks to the Internet, searching for the key indicators is a lot easier. When looking for population growth, the first stop should be www.census.gov, or you can simply Google, “City population increases.” For job growth, I use www.city-data.com, and for a look at rent growth by market I go to www.census.gov.
Sources for a look at appreciation by market include: CBRE, Millichap, and Yardi Metrix. Another great source that I use is VeroFORECAST. These are all good tools to use when doing analytics on out of state markets.
Step #2: Establish Your Investment Criteria
Before investing in any multifamily property, you have to have a plan. Do you want short-term appreciation or long-term stability? Are you willing to invest in a high-risk venture? What length of holding period are you comfortable with? Finally, what rate of return are you after?
The answers to these questions and others of a similar type will help you formulate your investment criteria. I look to reduce the risks in each multifamily investment while looking to maximize my returns.
Other things to consider are your exit strategy, meaning how you plan to dispose of the property after the hold period. Also, look at whether you want to do a value add deal, which adds improvements to the property in hopes of increasing rents and increasing overall income and appreciation.
Step #3: Build a Team
Investing in multifamily properties on your own isn’t a viable way to go, if you don’t have a team in place. You need to build a team that can support you in areas where you may not have knowledge or experience.
Who should be on your team? Start with a broker. When investing in properties that are out of state, you must cultivate strong relationships with local brokers. They are really the gatekeepers, who have knowledge of deals before they’re put on the open market.
Additional team members needed are a CPA and a lawyer. Pay particular attention to choosing your legal and financing team members that have experience in out of state investments. These types of investments require specialized knowledge, and are required in order to protect your interests.
A strong property management company in the out of state market is also a critical part of your team. They have the local knowledge needed as well as the experience to manage the property.
Finally, you might want to consider a local partner, one who is in the market and can search for deals, visit the property, meet with brokers and manage the asset after the deal is closed. It could be someone who will do some or all of the above.
How do you find your team members? When it comes to property mangers, a CPA or lawyer, ask the broker you’re working with for recommendations. They have worked with many professionals and can provide names of people you can interview. For brokers, network! As long as you know your investment criteria, you can find a broker that fits into your investment strategy.
As for a local partner, attend meetups and conferences. That’s the best place to meet people face-to-face and see if there’s a comfortable fit.
Step #4: Analyze Deals
You’ve done your homework, establishing your investment criteria, finding a broker and building a team. Now that you have these things in place, it’s time to start analyzing deals. What do you look for when doing your due diligence on a property? Let’s take a look at some of the basics.
You want to calculate the effective gross income (EGI) of the property. It’s the potential income minus any vacancies. Another key indicator on a deal is your net operating income, or NOI. This number will give you the total cash flow before mortgage and taxes. It determines the value and profitability of the property, so it’s a very important number to know. It’ll help you look for ways to increase it, by increasing the income or lowering the expenses.
There’s also the Cap Rate, showing what your return would be if you paid cash for the property. The lower the cap rate, the higher the price you pay. Higher cap rates usually lead to higher returns, but a cap rate that is too high can be indicative of a risk in the investment. The national average cap rate is around 5%.
Other terms you should familiarize yourself with are Cash-on-Cash (CoC), Internal Rate of Return, or IRR, and Average Annual Return. All of these help determine the return on your investment. Each term has it’s own meaning and purpose.
Step #5: Close
After looking at all the numbers, and deciding to invest in the out of state property, close the deal. Negotiate the price, put in a bid, and if you’re successful have your team members review the deal and help you move forward.
If you don’t have experience investing in multifamily properties, the best thing to do is partner with experience. Find a syndicator who has a good track record in multifamily investments. Become a passive investor, and reap the rewards without having to to the hard work that involved with managing an asset.
While purchasing a local multifamily property has its advantages in that you already know the market, it pays to look at out of state properties for the reasons outlined above. States without rent control or laws that favor tenants are advantageous to landlords. And markets that have good population growth, job growth, and rent growth are markets where you should be investing your money. After you choose a market, just make sure you outline your investment criteria, build a team, and start analyzing your deals. It will be a journey, but a fun one.
Are you a real estate investor and interested in learning more about passively investing in multifamily properties? Click here for the “Ultimate guide for the Passive