How To Invest In and Manage Out-of-State Property
How To Invest In and Manage Out-of-State Property
There are so many ways to invest in real estate, but one area that people don't talk enough about is investing in out-of-state properties.
Owning property in another state can open a Pandora's box of rules, regulations, and considerations, but it can also be a lucrative addition to your portfolio and long-term investment strategy.
1. Get Clear On Your Goals
Before starting your search, think through your goals for the property. Do you seek passive income, high-growth, a long-term investment, or do you primarily want portfolio diversification? Determine your priorities and exactly why you are considering this investment.
- Are you interested in areas with high-growth potential?
- Look for places where both population and job numbers are rising.
- Do you want to focus on a long or short-term rental?
- That choice may influence the type of property you purchase and where it is. Short-term tends to perform well in tourist destinations, whereas long-term rentals are often best in larger cities—but are you prepared for a tenant lull?
- Is this an area where you may want to live or travel someday?
- Perhaps you can purchase your retirement home or vacation getaway now but have it “pay for itself” via passive income until you are ready to relocate.
- Parents of college-age students may want to purchase a property near their child’s school.
- This can work well for your portfolio in several ways. First, your child can live on the property while in school, saving room-and-board fees. Buy a two-bedroom or larger dwelling, and the income from renting to students should provide a steady income. The downside? College students and property damage are almost synonymous. To determine whether this is the best option for you and your child, compare the costs of renting a property versus purchasing for four years. Consider the equity built up in the property you own and the ability to continue renting the dwelling after your student graduates.
Understanding your goals gives you a better framework for making the right investment decision for you.
2. Familiarize Yourself With The Market
There may not be that many great deals in rental real estate in your own locale, but you know the area. When you buy out of state, rental property may be more affordable, but you may not know the best (or worst) neighborhoods, accessibility, school districts, walkability and the like.
It’s imperative to study the market carefully you're considering investing in. You’ll need to determine the following:
- What are housing prices like?
- Is the area growing?
- Is there a strong rental potential?
- Is the ROI better than you would receive on property closer to home?
Once you have the answers to these questions, you can move forward with a property purchase or determine it’s not suitable for you at this time.
Don’t buy a property sight unseen, no matter how good the photos and videos appear in real estate ads. That’s part of your due diligence. Take the time to travel to the area and visit potential rental income properties. You want to find out what the ads aren’t including, so you need to see it in person. For instance, the house may appear just right–until you step inside and realize there’s a moldy odor.
Check out the neighborhood. Is it up-and-coming or heading on a downward trajectory? If you still like the property, have it inspected. You should know exactly what you're getting into before putting down that type of money.
Rental property regulations vary from state to state, making it imperative to understand the laws in the state in which you plan to invest. On the local level, you must familiarize yourself with municipal ordinances, zoning, and other local codes. Make sure you understand landlord/tenant laws. Some states are far more landlord-friendly than others.
For best results, invest in a property located in an area with low property taxes and relatively few regulations.
3. Hire Trusted Local Professionals
Location, location, location is the real estate mantra, which applies equally to trusted local professionals in an out-of-state property investment.
Start by working with a realtor you trust. A good realtor will know the best professionals in the area to service your rental property, like property managers, contractors, and other local pros you can rely on when something goes wrong. It doesn’t matter how handy you are if you're in South Dakota and your investment property in Florida has a water leak. Traveling to fix it yourself probably isn’t an option (or within the budget), so that’s where your property manager comes in.
A property management company generally charges a fee between 4% and 7% of rental income. However, expect to pay as much as 10 percent on smaller properties. While property management fees affect your return, a good property management company is your best option when you own an out-of-state property. For that fee, your out-of-state real estate investment becomes a turnkey operation. Property manager duties include:
- Collecting rent
- Keeping records
- Filling vacant units
- Screening tenants
- Scheduling repairs and maintenance
- Dealing with tenant complaints and emergencies
- Regular inspection to ensure the property is maintained
- Enforcing lease agreements
- Handling any evictions
For example, our Wealth & Trust department held property in Monterey, CA, while settling an estate. The property was well kept, but our main challenges were finding tenants that could afford the rent and ensuring we could maintain the property. The distance from South Dakota to California was a significant impediment to successfully managing this property. So we found a capable local property manager to address those matters.
Remember that you can have all the original hardwood floors you want, but if you don't have a well-managed property, it's unlikely you'll find financial success.
4. Crunch The Numbers (All Of Them)
Crunching the numbers on any real estate investment property is vital. Additional number crunching may be necessary when that property is located in another state.
Investing in physical property is costly, making it critical to know precisely how much money you have to invest so you don't go overboard. If you spend your entire budget purchasing the house, what will you do when the roof leaks and needs to be replaced a month in?
These are the numbers to consider:
- Down payment—generally, you’ll need at least 20% down if it’s an investment property.
- Mortgage payments if the unit is empty
- Property taxes
- Property management fees
- Realtor fees
- Cost of tenant background checks
Then, there’s rental property insurance. This insurance covers property damage but also offers personal liability protection if the tenant or their guest is injured on your property and decides to sue you.
It’s also wise to budget for tenant delinquency. Even though you’ve screened tenants carefully, life happens. Unemployment, divorce, illness and a host of other issues can mean even the best tenant can’t pay rent.
5. Ensure Out-Of-State Property Is Best For Your Portfolio
Is out-of-state property the best choice for your portfolio? While it can bring diversity and passive income, it’s not the right strategy for everyone.
For some investors, putting their money into a Real Estate Investment Trust (REIT) may make more sense than buying your own property. A REIT is comparable to purchasing mutual funds or ETFs—you access a pool of diverse investments rather than just one company’s stock, or in this case, one house.
At First Dakota Wealth & Trust, we can work with you to evaluate all your options regarding adding real estate to your portfolio.
6. Know The Risks
Once you’ve gone through all the steps above and decided buying out-of-state property is a good fit, you can move on to evaluating the risks. The two most significant risks are:
- Local property problems. Anticipate and plan for potential problems. When issues with the house or tenants occur, distance can prove very expensive. Retaining good, solid local management companies and real estate professionals can make all the difference.
- Undercapitalization. Real estate is cash intensive, so ensure you have sufficient capital for your project.
Keep an eye on your long-term numbers to ensure they work out. Determine beforehand the length of time needed to break even and turn a profit. Is this venture continuing to work for your long-term financial and personal plans?
For more information about whether investing in and managing property out-of-state is right for your portfolio, contact Larry Leet, Senior Vice President of Wealth & Trust at 605-665-4926.
First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.
Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust Department, or its employees provides tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.