When done right, investing in real estate is a proven way to earn income while building equity. But depending on your budget and investing goals, the market that’s right for you may well be in another time zone.
While the majority of people prefer to buy investment homes close to where they live — which makes sense on some level — this method forfeits one of real estate’s best advantages: the diversification of risk.
When does it make sense to broaden your search footprint to a different city or state?
More often than you think.
The way people invest in real estate is very different than it was as recently as a decade ago. Thanks to new technologies and improved data access, buyers can purchase with increasing confidence in top rental markets across the country without physically being there.
If you want to get on the property bandwagon but aren’t sure whether to invest locally or branch out, consider the following:
1. Do you live in a strong rental market?
Not all real estate markets are created equal when it comes to owning an investment property. Some will appreciate rapidly, while others grow slowly and steadily. Some might have attractive gross yields (which represents the ratio of rents to purchase price) but come with higher vacancy rates or more volatility. Certain coastal markets have extremely high barriers to entry and very strong rental demand, while other Midwest and Southwest markets hit the sweet spot between entry price and market rent.
For many investors, finding properties that meet your investment goals close to where you live may prove challenging. Perhaps you live in Seattle, Southern California or the San Francisco Bay Area where the median list price is roughly $670,000–$1.2 million, and current returns are marginal or negative, according to our projections at Roofstock. Or maybe you reside in a hot rental market such as Denver, and typical list prices are starting to crawl above your budget threshold. Rather than over-leverage yourself or throw in the property investing towel altogether, consider broadening your search to other more affordable markets that offer attractive returns uncorrelated to where you live.
Homes in other areas such as Indianapolis, Cincinnati, Memphis and Cleveland might not appreciate as much, but offer attractive entry points in the $80,000–$190,000 range and high 11–13% average gross yields, with the potential for net yields in the 6–7% range or higher, according to our projections. These yields can be even higher with leverage, which is readily available from Fannie Mae and Freddie Mac at attractive rates for individual investors.
As you can see, many variables influence a market’s desirability. When choosing a location, consider your budget, risk tolerance, desired returns and investing criteria. Do you care about higher cash flow? Renter stability? Long-term appreciation? Do you plan on moving there someday?
It’s not so much a question of “Can I invest in rental property,” so much as it is a question of where.
2. Do you seek diversification?
While purchasing an investment property close to where you live is arguably more practical, this leaves you with all of your risk concentrated in one geographic region. By spreading your real estate investments across different markets, you avoid “doubling down” on the same area where you own your primary residence.
For example, if you work at Google, buy a property in Mountain View, California and only own Google stock, you’re putting all of your eggs in one basket. Tying your investment to a different economy allows you to de-couple the risk between where you live/work and your passive investment strategy.
Additionally, if you’ve ever worked with a financial advisor, you know that having a diversified portfolio of non-correlated assets (bonds, real estate, stocks, etc.) is a best practice. This also applies to rental property investing: While your primary residence and investment home(s) may have low correlation to the stock market, they could still be highly correlated to each other if they’re located in the same area.
3. Do you plan on moving down the road?
If your heart is set on eventually becoming a full-time ski bum in Denver, moving closer to family in Nashville or retiring in sunny Phoenix, consider getting your foot in the door now. That way, you can start building equity and collecting rental income, and you can avoid potentially higher list prices when you’re finally ready to move.
There are other benefits to investing sooner rather than later, too. This includes enjoying the substantial tax sheltering afforded by investing in real estate, which allows you to deduct certain operating expenses as well as depreciation on the assets.
And remember, even if home values fluctuate in the years after you buy, rents tend to remain resilient. This means you can more easily ride out cycles in the market as you continue to collect rent on your investment property.
For example, during the five years home prices dropped during the recent housing crisis, average rents for single-family rentals never declined on average, according to single-family rental data from Zillow. This makes sense when you think about it since during that time millions of families lost their homes and became renters, increasing the demand for rental homes.
If you’re able to buy now, I encourage you to team up with a local property manager who cares for your investment and handles the day-to-day responsibilities such as tenant communication, leasing, maintenance, etc. This will allow you to separate investing from operations and view your rental homes more like any of your other investments, not requiring daily TLC.