In a prior article I discussed why I decided to invest out of state and some of the tactical steps I took to make that happen. In today’s quick snippet I will focus on the four risks that out of state investing entails and how to mitigate those.
1. Lack of market knowledge. When purchasing a property out of state it is important to know your market and submarket, understand the latest trends (e.g. supply coming on market, new employers moving into the area or leaving the area. And while you can perform a ton of research online, nothing can replace the local boots on the ground knowledge. This is where your boots on the ground contact (property manager, friends & family, or your own research if that is a place you lived in or frequently travel to) comes in handy. For example, a $60K home in Memphis, TN may sound like a great deal for a Los Angeles, CA investor. However, there is a reason why the price point is so low relative to other homes in Memphis, suggesting a more risky area or tenant base and possibly an area locals would avoid altogether.
2. Limited ability to verify or control operations. There is something to be said about having the property within a short drive from your home where you can periodically check on the exterior upkeep or have good familiarity with local costs for repair and maintenance. While you do not have that luxury when investing out of state you can form a team of trusted individuals (David Greene called it the core four in his book on out of state investing), which include your property manager and contractor among others. While you are still one step removed from the daily operations, you can review financials and invoices and even do mystery shopper calls to verify the numbers, so over time you can easily spot outliers. Before and after pictures can help substantiate maintenance requests. And as long as you have a system in place, you can easily spot outlier maintenance requests too.
3. Not all markets are created equal. Each market and submarket is different, including counties within the same state or even cities within the same county. Apart from market indicators discussed previously, it is important to keep in mind that certain states may not have income tax but in exchange have a higher property tax than you may be accustomed to at home. Cities or submarkets close to the coastal or other natural disaster areas may also carry higher insurance premiums (we are experiencing exorbitant increase in insurance in Florida for example). While you do not control the local tax policies or how insurance companies do business, you want to understand the specifics to your market and factor that into your underwrite.
4. Perform additional diligence on state periodic filing requirements (as applicable) to stay compliant. It is not uncommon for out of state owners to purchase the property in an LLC formed in the state the property is located in. As such it is important to familiarize yourself with the annual reports and annual fees requirements to keep your entity compliant. The last thing you want is a notice deeming your entity invalid, which can also trigger a default under your loan documents. Similarly, you want to ensure you file out of state tax returns, if so required. Lastly, if you happen to live in California, you want to ensure you register those out of state entities and pay the annual franchise California fee, if applicable. Having a good attorney and tax advisor on your side can help you navigate through those requirements.
Investing out of state can feel scary. However, as long as you identify key risks upfront and put together systems and processes to mitigate those and perform proper diligence, you will be better prepared. Ultimately do not forget that this is a learning journey too – you will not know everything that could go wrong or even regulations that may change over time. Learning from those experiences too will better position you for your next investment and help you grow as a real estate investor.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.