They say real estate is all about â€ślocation, location, location.â€ť Thatâ€™s especially true when it comes to investing in rental properties. Where you choose to buy can have a significant impact on your return on investment.
For example, in a state like New York, where the median mortgage exceeds the median rent by nearly $250, buying a property to rent out doesnâ€™t make much financial sense. If you consider buying rental property in a different state, such as North Carolina where rents in the city of Charlotte top mortgages by $84 per month, youâ€™ll net a profit instead of a loss every month your tenant pays rent.
Before you start the interstate home search process, you should know the risks and rewards of out-of-state investment properties.
Very often, the primary reason to buy an out-of-state rental property is investment properties where you live are too expensive. There are some other more strategic reasons that weâ€™ll cover next.
Real estate markets rise and fall. During the housing boom of 2003 to 2007, many of the â€śsandâ€ť states, such as California, Arizona, Florida and Nevada, experienced home price appreciation at rates well above historic levels.
Investors learned a painful lesson in the danger of not diversifying when the housing markets in those states crashed during the housing crisis. Investors who had investment real estate concentrated only in these states lost big, while those who spread their portfolios out to other states fared better.
If prices and rents are competitive in a state youâ€™ve always wanted to vacation in, you may want to purchase the property first as a rental and allow tenants to build some equity for you while you generate income. After a few years, you may decide you want to spend a few months a year vacationing in the home and rent it out seasonally with a rental plan from a service such as Airbnb or VRBO.
Alternatively, you may live in a cold-weather state, such as Massachusetts, and want to retire to the warm winters of Arizona. You could put the wheels in motion on your retirement plans by buying a rental property there first that has the amenities you would want in a home for retirement.
Once youâ€™ve pocketed some rental income and equity from renters, you can pack up for the cross-country move into the rental, throw out the snow shovel and enjoy wearing shorts instead of parkas during the holiday season.
Short-term rentals have become very popular for real estate investors, but they face legal challenges in some places. For example, New York City subways are covered with signs warning riders to avoid short-term rentals.
If you are interested in renting out your property through a service like Airbnb, buying in a state that has more flexible laws about short-term tenants is your best bet.
According to a recent LendingTree study, homeowners in San Jose, California, paid on average $9,626 in property taxes each year. In Salt Lake City, homeowners pay only $2,765 per year â€” which means youâ€™d have to get an additional $567 per month in rent in California just to cover the property tax expense before you could make any profit.
Like any investment, there are risks associated with buying out-of-state rental properties. Weâ€™ll discuss those next.
If you have a rental in the city you live in, you can deal with an unexpected tenant move-out or a late-night plumbing problem by driving over to the property and taking care of the issue yourself. But youâ€™ll need to make some decisions about how to manage an out-of-state rental.
If you hire a property management company, theyâ€™ll take 8% to 12% of your monthly rent as a fee, eating into your monthly rent profit. If you self-manage, youâ€™ll need to make sure you build relationships with local handymen, roofers, plumbers and pest control professionals so you have their numbers handy if a tenant emergency comes up.
Short-term rentals, such as Airbnb, may be a great way to generate a higher monthly income than you would get with a 12-month lease, but some cities and neighborhoods arenâ€™t too keen on having a lot of different people coming and going through a nearby house. If the laws prohibit short-term rentals in an area youâ€™re interested in, youâ€™ll have to crunch the numbers to see if market rents for long-term leases provide you with a good return on your rental investment.
When youâ€™re buying in another state, take extra precautions to make sure you understand everything about the local housing market, building standards and how the local economy is doing before you start making offers. The last thing you want to do is end up with an out-of-state money pit.
No matter how nice the home may look in pictures or at an open house, there can always be problems beyond the smell of new paint and carpet. Building standards and practices may vary from state to state and city to city, and you donâ€™t want to be caught by surprise because you didnâ€™t know polybutylene pipes behind the walls of homes built in Tucson, Arizona, have been known to burst without warning.
A good local home inspector will also help you understand whether a property has been built and maintained according to local building standards and identify any issues, such as an unpermitted room addition, that could cause you trouble with local housing inspectors down the road.
Depending on the town, you may find very high-tech, organized property management shops with decades of experience or small mom-and-pop shops that offer real estate property management services. Either way, you want to know what they do for their fee. The graphic below provides a list of questions you should ask to make sure the property manager is a good fit for your out-of-state rental.
Property taxes are a fixed expense you canâ€™t get around paying, so be sure to track the last five years of property taxes to see what the average increase has been. If youâ€™re seeing an acceleration in the tax rate, figure that into your return-on-investment analysis, so you donâ€™t end up in a situation where your monthly expenses are more than the rent youâ€™re taking in.
Rental markets ebb and flow as new homes are built, new employers set up shop nearby or new schools are built in the area. A good property manager or experienced real estate agent should be able to give you a good idea of where the market is headed with a comparable rental analysis.
When you bought your first home, you may have gotten a comparable market analysis (CMA), which analyzes what homes are selling for in the area youâ€™re thinking of buying. A comparable rental analysis looks at rentals nearby to give you an idea of what your monthly income is going to be.
If you finance the property with a mortgage, youâ€™ll likely need a rental analysis form 1007, which is an additional report in a residential home appraisal that provides an opinion of the market rent for the home youâ€™re buying. In some cases, the appraiserâ€™s projected market rent can be used to help you qualify for the new mortgage, even if you donâ€™t have a lease on the property youâ€™re buying.
If youâ€™ve been buying investment property in your hometown, you already know financing a rental property comes with higher down payments and interest rates. There are a few more factors to consider.
Depending on what state you are buying property, transfer taxes may be charged for you to take ownership of the property you are buying. Unlike property taxes, these are a set lump sum percentage of your sales price, added to your closing costs.
Transfer taxes are often paid by the seller, but in some cases they may be payable when buying a home, adding to your total closing costs. Itâ€™s also good to at least know how much they are so they donâ€™t end up being one of those hidden costs of selling a home. In places like New York City, that could mean an extra 1% to 2.625% of your sales price subtracted from your profit, in addition to real estate fees that usually run between 5% and 6%.
Depending on where you purchase your rental property, you may need an attorney to handle your contract negotiations. That means higher costs than youâ€™ll find in an escrow state, where an escrow offer can handle the signing usually at a much lower cost.
If youâ€™re currently married or have a domestic partner, the community property laws could affect what happens to the property in the event of a divorce. Community property states require a split of equity down the middle, whereas the equity can be split up in negotiable amounts in a non-community-property state.
A little due diligence and research will help you avoid unpleasant surprises if youâ€™re considering buying an out-of-state investment property. While many real estate companies offer â€śvirtual toursâ€ť of homes, thereâ€™s nothing like an in-person tour to soak up the light, views, smells and feel of a home before you buy it.
If you can, budget enough time to take a trip to the state youâ€™re considering buying in to inspect the top contenders before you start making offers on an out-of-state investment property.
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