Earlier this year, I set a goal to buy an out-of-state rental property within 90 days. While it took about a month longer, I was able to check this goal off of my list. The reason I wanted to buy rental property was to diversify my portfolio. At the time, I was heavily invested in stocks.
Some people will argue that you can buy stocks in Real Estate Investment Trusts (REITs) to diversify, but to me, REITs are still tied to the stock market. Additionally, I would be missing out on the tax benefits of owning real estate.
But why not just buy locally? I would prefer to buy locally, but the numbers just do not make sense for San Diego and the rest of California. You cannot get anywhere close to 1% where I live, so I decided to go out of state.
Without further ado, here are the 9 steps that I took to buy my first out-of-state rental property:
1. Perform market research
Buying in an area where I had never lived nor visited, as you can imagine, had its challenges. First, with so many cities, how do you decide where to invest? I started by looking at where turnkey companies and other investors were investing. I used turnkey-reviews.com for a list of turnkey companies, then I visited their website to see which market(s) they invested in. By piggybacking on other people’s research, I was able to narrow down the cities that would make financial sense to invest in.
Next, after narrowing it down to 3-5 cities, I looked at metrics such as population growth, job growth, price-to-rent ratio, appreciation potential, property tax rates, and whether the state was considered landlord-friendly (i.e., in the event that a tenant had to be evicted, how long would it take to process the eviction?).
I found people who became financially independent through real estate and studied how they did it. I also read books that were recommended by these people, such as John Schaub’s Building Wealth One House at a Time.
2. Network, network, network!
I was able to find a lot of information on the internet, but the most useful and insightful information that I found came from actually speaking with other investors about their experience investing in that market. I visited BiggerPockets.com and read the forums. I focused on the city-specific forums, so in my case, I read through many of the posts in the Jacksonville local forum. I then reached out to posters (investors and agents) who posted quality comments/content.
TIP: You can also attend your local REIA (an investment club) to see where people are investing, but be careful at these events as they may sometimes be sponsored by folks who are trying to sell you something. I personally did not attend any REIA meetings, but many experienced investors recommend them.
3. Build a team
Based on the referrals from the people that I networked with, I reached out to the local experts to interview them and see if they were the right fit for me. The first person that I started with was the real estate agent. From there, I got a referral from her for the lender. As I progressed, I added the property manager, property inspector, and general contractor/handyman.
What I looked for:
Real estate agent: I looked for someone who has experience working with other investors. It’s also helpful if they personally invest in the area because they know what kind of property would make a good rental. The agent shouldn’t be selling me on the emotional features of a property (e.g. using words like “beautiful” or “cozy” to describe the home), but should point out the features that will make a good rental (vinyl flooring, low maintenance yard, etc.) and upgrades that can be made at a cost effective price (e.g. re-glaze the bathtub instead of replacing it).
Lender: I looked for someone who is experienced working with investors, who can close quickly, and can give me a competitive rate. I realized the value of a good loan officer when one loan officer was able to get me pre-approved, while another (from the same office) could not due to his inexperience. The inexperienced person did not know that he could count 75% of the market rent of my other property as income to qualify me (when I did not have the two years of tax return to back it up). As it turned out, I just needed a signed lease agreement to count that income. Most loan officers will match the rate of a competing offer, so I made sure to get multiple quotes for the best rate.
Property manager: The property manager is the expert on the rental market. Among other things, he should be able to tell me which neighborhoods to stay away from, what updates I should make to a property to get a higher rent, average list time before filling a lease, his average lease length, etc.
4. Get pre-approved
Generally, I try to get pre-qualified with at least three lenders to see which lender offers the best rate. Even if I already have a lender that I want to work with, I will still try to get additional quotes so I can ask my preferred lender to match the rate (they usually will). I get pre-qualified with all lenders all within a 30 day period so it does not affect my credit score (the lender will consider it rate shopping and won’t count it against me). Once I am pre-qualified, I get pre-approved with my lender of choice.
TIP: Your offer is stronger if you have a pre-approval letter to go with it, so I always get this completed before I even start touring properties. You will also need to know if the lender will require 20% or 25% down, what the estimated closing costs are, etc. to run your calculations to determine if the property is a good deal.
5. Find a property
Initially, my agent set me up with an MLS search alert, but that got overwhelming since I didn’t know the neighborhoods well. It’s better to ask them to send you curated deals where they have done a preliminary review and determined that it might make a good rental. During the search process, my agent moved out of the area, so she referred me to another agent, who was a top producer in the area and has a lot of experience working with investors. After I sent the new agent one property that I was interested in (which sold quickly), she had an idea of what I was looking for and started sending me similar properties. Once I got to know the area well, I actively searched for the properties and set up my own alerts. For the properties that at least met the 1% rule, I would send the listing to my agent. My agent would then tour the property and send me a recorded video tour of it. I specifically instructed her to look for properties that only needed cosmetic repairs. I asked her to note any awkward layouts and any huge liabilities on the property (e.g. pools, large trees too close to the property where the tree roots can grow into and destroy the underground pipes, etc).
6. Analyze the property
After my agent sends me the video and I’ve determined that the property might work, I would run the numbers based on the condition of the home.
When running the numbers, I accounted for principal, interest, tax, insurance (PITI), property management (10-12%), leasing fee (I used the leasing fee provided by the property manager and divided by 12 since most leases are for one year), vacancy (I used 8%), maintenance (I used 10%), capital expenditures (I used 10%), HOA (if any), and any other expenses that the landlord is typically responsible for in that area (e.g. utilities, yard maintenance, etc.). For insurance, I requested insurance quotes from State Farm and an insurance brokerage in Jacksonville. For the tax, I checked the county tax assessor records. I subtracted this number from the projected monthly rent, which I estimated using rentometer.com and HotPads, to determine my monthly cashflow. I needed to at least break even after accounting for all of the aforementioned expenses. Some investors look for at least $100-200 in monthly cashflow per house, but for me, I was okay with $50-100 in monthly cashflow (I was doing this first one more for the learning experience so I was willing to take a smaller return–you will get better after each deal).
Projected monthly rent
minus Property management (10-12% of projected monthly rent)
minus Leasing fee (I used the amount provided by the property manager and divided by 12)
minus Vacancy (I used 8% of the projected monthly rent)
minus Maintenance (I used 10% of the projected monthly rent)
minus Capital expenditures (I used 10% of projected monthly rent)
minus HOA (if applicable)
minus Any other expenses
= Monthly cashflow
7. Submit an offer
It’s time to submit an offer! Even though I came up with a number that made sense to me, I would double check with my agent on what she would suggest since she has the local knowledge as to what properties have been selling for (compared to the list price), how much closing cost is typically offered, etc. That said, if she suggested a higher number that wouldn’t make the deal a profitable one for me, I will go ahead and ask her to submit it at the lower price.
Coming from a competitive market in San Diego where properties sell very quickly and properties usually sell over the list price, I was glad that I checked with my agent when she told me to offer less on one property and ask for more closing cost on another. This is why you need an experienced agent working for you.
8. Perform due diligence
Once I had an accepted offer, my agent scheduled the property inspection before the time ran out on the inspection contingency. After we got the inspection report back, my agent quickly obtained quotes for the repairs to use in negotiating a lower price.
TIP: You should always try to negotiate repairs after you get an inspection report. No home is ever perfect–there is always something you can negotiate. Re-run the numbers if the seller counters with less than what the estimated cost of repairs is. You always need to make sure that the numbers make sense. Now is also the time to talk to the property manager about the neighborhood and fly out there if you plan to look at it. If the property has an HOA, read through the CC&Rs and reserve study and make sure that the HOA is doing well financially.
9. Close escrow
After everything checked out, I moved on to the final step, which was also the most exciting!
My escrow company coordinated with a mobile notary to meet me at my home to sign all of the paperwork.
Before escrow closed, I instructed my agent to turn the key over to the property manager after escrow closed.
I’ve read that you will make mistakes with your first deal–it’s part of the learning process–so I always kept this at the back of my mind to keep things in perspective. I’ve learned a ton from this first out-of-state purchase so far and will be applying the lessons learned to the next one.
Was there anything about this process that surprised you?