Buying out of state can be a daunting proposition for many real estate investors but the fact is, most of what can go wrong can happen whether you’re investing in your own hometown or 1000 miles away. You can get a bad tenant in your local market, or an AC unit can go out regardless of where the property happens to be. Although it can be costly, neither one is fatal to your investment and can be overcome as long as the property is in a good location. You can evict a bad tenant. You can replace a broken furnace, but you can’t move a house that’s in a bad neighborhood. In most cases, the only way out is to sell the property and cut your losses. Which leads me to the biggest mistake out of state investors make.
We’ve all heard the old adage that “location, location, location” is the most important factor when buying real estate, and that is especially true of investment properties. Choosing a neighborhood that fits your investment criteria is one of the most important decisions you’ll make as an investor. The type of neighborhood and class of property can mean the difference between solid, reliable cash flow or heartache, expenses and loss.
But how do you know if you’re buying in a good area if you don’t live there? This can be a challenge for out of state investors. I’ve heard far too many horror stories of how investors thought they were buying in a good area only to find out after the fact. that they bought in the hood and they are stuck. Unfortunately, it often comes as a total surprise leading to the all too familiar exclamation “I thought it was a B class neighborhood!”.
So how do you know if you’re buying the right property in the right area?
In real estate, properties and neighborhoods are commonly rated as A, B, C or D. Neighborhood classifications are a good starting point but they have their limitations. They are very subjective so what may be one person’s B-Class neighborhood can be another person’s C-Class neighborhood. These classification systems generally rely on a number of factors that go into the rating. The problem with this is there is no one place that you can go and get this information. It requires your own due diligence. Although there are sites that attempt to score neighborhoods on a number of factors, I have not found these sites to be very reliable and can often lead to bad decisions. I have seen cases where a highly desirable, affluent, owner occupied neighborhood is ranked the same as a very dissimilar, crime ridden neighborhood. The lesson to take away from that is that even in the age of instant information, there is no short cut. There is no substitute for doing your own research.
Let’s break down the most important factors that determine the quality of a neighborhood.
Crime rates. Crime is the most important factor in determining the quality of a neighborhood. You want neighborhoods that people want to live in and that attract good tenants. Trulia’s heat map is a fairly good source of information on crime rates but it is dependent on data from the local police jurisdiction. Because every jurisdiction reports crime data differently, it can lead to inconsistencies between markets. In addition to crime heat maps, another good source of information is simply doing a Google search of the neighborhood. If it’s a bad neighborhood, you’re likely to find articles about shootings, assaults and robberies, whereas in good neighborhoods, you’ll find information about development projects, new companies moving in and cultural events taking place.
School ratings. A-Class neighborhoods will generally have good schools, however, that is not always the case. Some cities have notoriously poor schools and people who live in A-Class neighborhoods often send their children to private schools. Although good schools are important to some investors, the reality is that most of the time, schools are not a big criteria for renters. According to the U.S. Census Bureau, 2/3rds of all renters don’t have children. Also, people live where they can afford to live. Someone who can only afford $900 per month rent can’t afford to live in great school districts where rents are $1200 per month. Most property managers require tenants income to be 3X the amount of rent. That being the case, they have to make $2700/month to qualify for a home renting for $900. On the other hand, they would have to make $3600/month to qualify for $1200/month rent. That is a significant income differential that a lot of people can't afford. I often hear investors say that they want a C-Class property with great schools without understanding that C-Class neighborhoods don’t have great schools, otherwise they wouldn’t be C-Class neighborhoods. I often hear investors say that they want a C-Class property with great schools without understanding that C-Class neighborhoods don’t have great schools, otherwise they wouldn’t be C-Class neighborhoods.
Amenities. The amenities in the surrounding tell a lot about what kind of neighborhood it is. If there are pawn shops, liquor stores and check cashing stores nearby, it’s a pretty good indication that it is not an A-Class neighborhood. On the other hand, A-class neighborhoods will often have shopping malls, anchor stores, Trader Joe’s and Starbucks nearby. Take a virtual tour of the neighborhood and see what’s nearby.
Owner-occupancy rates. A-Class neighborhoods typically consist of primarily all owner-occupied single-family homes. B-Class neighborhoods will be made up of a mix of rentals and owner-occupied properties with some multi-family properties. C-Class neighborhoods will be primarily rentals. Finding occupancy rates for a neighborhood can be difficult however. Sites like City-Data often have data on owner occupancy rates however, it is usually at the zip code level which isn’t very meaningful since some neighborhoods can vary block to block. Google Maps street view can tell a lot about the street. Owner occupied neighborhoods will have some very obvious characteristics. There will usually be a level of pride of ownership with well maintained homes and landscaped front yards.
Types of homes. A-Class neighborhoods will have newer, larger homes. They will typically be 3-4 bedrooms and 2 or more baths. B-Class are typically 3 bedrooms and 1 or 1.5 baths while C-Class are commonly 2-3 Bedrooms and 1 bath. Square footage can vary significantly by market, so get to know what is common in your market.
One simple and obvious but often overlooked method of deciphering a neighborhood class are prices and rents. This can be the most reliable determinant of the quality of a neighborhood. Spend some time familiarizing yourself with price and rent ranges. Learn what the median price and median rent is in your market are. Use sites like Zillow to identify the prices and rents in your neighborhood. See where those fit in relation to the medians for the market. If the median rent is $900 and your property rents for $600, you can be sure it is a lower-class neighborhood.
The table below shows the typical price and rent ranges by property class for many Midwest markets.
Lastly, talk to a property manager that knows the area. Ask them how they would characterize the neighborhood and what type of tenant it would attract. Additionally, ask them what challenges they foresee managing a property in that neighborhood.
Buying in a good neighborhood is the most important factor in the success or failure of your investment but with proper due diligence, there is no reason to be surprised to find the neighborhood you bought in is not what you expected, even if you’re an out of state investor.
Have you ever bought in an area and discovered that it wasn’t what you expected? If so, what did you do?
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