Investing in Out-of-State Property
Buying and owning property is rarely easy or simple. When the property in question is in a distant location, the challenges multiply. Nevertheless, investing in out-of-state property might seem appealing if you live in an area where real estate is expensive. It might also appear attractive if you already own property where you live, and you want to diversify your holdings. Or you may just want to own a vacation home. But before you make an offer, carefully consider these issues.
Reasons to Buy
One factor that leads people to consider buying property far from home is that property may be more affordable in another state. Perhaps you live in an area like San Francisco or New York City, where property costs are sky-high. If you simply can't afford to buy a place where you live or if doing so would require investing the majority of your money in real estate (which you'd rather not do), you may want to look at other cities where market fundamentals are sound, but property costs are significantly lower.
People who live in depressed areas but don't want to move for work or personal reasons may be better off renting in their hometown and investing in real estate where the economy is stronger. For example, if you lived in Las Vegas, the city with the highest foreclosure rate during the 2008 subprime meltdown, you might have wanted to buy property in a market where median sales prices remained relatively stable, like Charlotte, North Carolina.
Perhaps the main reason people decide to invest in property out-of-state is that the return on investment (ROI) may be better there than it is at home. Purchase prices, appreciation rates, mortgage expenses (if any), taxes, housing regulations, rental market conditions and more are all factors that might be more favorable in another state and will contribute to a property's potential ROI.
Challenges to Consider
When you invest out-of-state, you must overcome your lack of familiarity with the out-of-state real estate market and with its local economic conditions, both at the city level and the neighborhood level. You won't have the same intimate, day-to-day knowledge of a distant market that you have of the market where you live. You don't have an in-depth understanding of the best neighborhoods – or the worst. You will have to rely on word of mouth, research, gut instincts and the opinions of any professionals you hire.
Understanding all the laws and regulations regarding property ownership and property taxes in a place where you don't live is another major challenge. Even if you read every line of the local codes and ordinances, what it says on paper and what happens in reality, don't always match up. It's crucial to talk with property owners in the area to gain a true understanding of local statues.
You'll need good contacts in the area to make your investment plan successful, but when dealing with a distant city, you may be starting from scratch in finding quality professionals such as real estate agents, property managers, and handymen – the people who will be the key to your success or failure.
The secret to many out-of-state investors' success is to find and hire an excellent property management company. You'll need them to help you fill vacancies, collect rent, make repairs and handle emergencies. If you lived in the area, you might choose to manage the property yourself, but if you live far away, professional property management is an extra expense you simply must incur to safeguard your investment. As experienced builder and property manager Rusty Meador advises, "No matter how good of a real estate deal you find, it is only as good as its ability to be managed well."
Be aware that even with a property management company on your payroll, you'll still need to make occasional visits to your property to make sure that what managers and tenants tell you matches reality. This is an additional time and money cost that must be considered.
Also, when purchasing a rental property, especially rental property out-of-state, you're likely to encounter higher homeowners insurance rates, higher mortgage interest rates, and higher down payment requirements because lenders will consider you a riskier borrower than an owner-occupant. You'll also complicate your tax situation by owning rental property and earning income in more than one state. You may need to hire an income tax professional to keep you in the tax authorities' good graces.
When considering all of these factors, you may find that being an owner-occupant or purchasing investment property at home is a much simpler and less expensive proposition.
Before You Buy out of State
If you're still intent on buying out-of-state, be sure to heed these additional warnings.
Do not buy sight unseen; the property may not be what you think it is. Online information on a property can be out-of-date, and a local real estate agent or property owner who isn't looking out for your best interests might lie to you to close a sale. If you unwittingly become the owner of a nuisance property that violates health and/or safety laws, you can find yourself on the hook for numerous code violations that will be time-consuming and expensive to fix. If a property has been vacant for long enough, it can develop maintenance issues that cause such disrepair that the city deems it a safety hazard and bulldozes it. You might even wind up on the hook for the demolition bill.
Some property investors have found bed bugs, termites, roaches, mice or other pests to be their downfall. Without an in-person visit to the property and a professional inspection to check for these issues, you could become the owner of a property that is not habitable. Scott Paxton of the Rental Protection Agency advises that bed bug complaints have become increasingly common and this problem can be very expensive to get rid of.
Finding quality tenants is extra important for absentee landlords. You won't be there to keep a close eye on your tenants' behavior or their treatment of the property, nor will you be there to pressure them to pay if the rent is past due. In addition to hiring a top-notch property management company, you want to have tenants that won't cause you or your management company any headaches.
Additionally, making an in-person visit to the location allows you to get better acquainted with the professionals who will assist you with the home-buying process such as your lawyer, real estate agent and lender. While you're visiting, take some time to meet with various lenders and research the various mortgage types and interest rates available locally. It is also beneficial to get pre-approved for a mortgage, as this will cut down on the time it will take to close the deal once you've finally found your dream out-of-state home.
Finally, if you've never owned property, buying your first property out-of-state is extra risky. No matter how many books you read on property ownership, there is no substitute for real-life experience. Without any experience in property ownership and without the firsthand knowledge that comes from living in a property day in and day out, you might miss important maintenance considerations.
If you don't think you want to buy property where you live for whatever reason, there are other ways to get into different real estate markets that are much simpler than investing directly out-of-state. One option is a real estate investment trust (REIT). Investing in a REIT or REIT ETF is similar to investing in a stock, and you can choose a REIT with a risk/return profile that fits what you're looking for. And just like when you own a stock, and you aren't responsible for making decisions about running that company, when you own shares of a REIT you won't have any of the headaches that are associated with actually owning a property.
You might also take a second look at buying property where you live – even if you don't want to live in it. Maybe you've been renting in San Francisco because you aren't interested in living in the only place you could afford to buy, a 250-square-foot condo. But would you be willing to own that condo as a rental property? It's likely to be easier to buy and own a place near your home. It could be more expensive or less profitable, but you may find the extra cost or lower ROI worth the reduced hassle.
How to Make it Work
If you are going to buy out-of-state, buy in an area you are familiar with – perhaps where you went to college or where you grew up. It's better to have some knowledge of the area than none at all. As a bonus, if you buy in an area that you normally visit anyway, your leisure travel can become at least partly tax deductible because you will be adding a business component to those trips to check up on your property.
Buy in an area with some similarities to the area where you live, such as climate, demographics or property age so that you have some idea of what you're dealing with. If you have lived in a 1960s suburb of California your entire life, don't buy a 120-year-old property in Boston.
Don't buy a high-risk property. Buy in a primarily owner-occupied neighborhood to attract tenants who are a lower economic risk, says Ryan L. Hinricher, a founding partner of the investment home sales company Investor Nation. A high-quality property will "typically have less maintenance and upkeep. These properties also rent more quickly, as they usually have modern layouts and an adequate count of bedrooms and bathrooms," he notes.
Finally, as mentioned earlier, it's crucial to build a great network of professionals to help you and to occasionally visit your property yourself.
The Bottom Line
Investing in property out-of-state is a high-risk proposition and a major commitment. Before you do it, make sure you truly understand what you're getting into and that you are prepared to meet all of the related challenges.