You’ve decided, for whatever reason, that you want to invest outside of your local area or state. Your next question is—where should I invest?
I’m going to offer you a list of things that you can consider when trying to figure out what market to invest in. These things are in no particular order, and some of them may not apply to you or your particular situation. My intention with each one is to give you something to think about and hopefully some ideas on where and how to start looking for what market you want to invest in.
Here we go!
Step #1: Narrow Down Your Market Options
First, if you are brand new to out-of-state investing and don’t have a clue where to start, your location choices are likely going to feel extremely overwhelming. I have two things for you to think about that will hopefully at least get you moving in some kind of direction:
Where do you have friends and family?
Are there any cities where you have friends or family who might be good assets to have on your “team” on the ground? I’m not necessarily saying go into business with your friends or family or make them an official part of the team, but if you already have ties to any particular cities, maybe take a little time to decide if any of those cities might be good ones to get started. Even if your friends or family there aren’t part of your team, they may be able to occasionally drive by your property once you own it and tell you if anything crazy seems to be going on. It never hurts to have an extra set of trustworthy eyes on an investment property!
Where are other investors buying?
Thanks to technology and the internet (and websites like BiggerPockets!), you can easily and quickly network with other out-of-state investors. Ask people what markets they are buying in, and if they seem friendly and interested in chatting more, find out why they are buying in those markets. Don’t struggle to reinvent the wheel when experienced investors are already out there succeeding with out-of-state properties. I did secretly throw a keyword in there—experienced. Don’t take just anyone’s word for what they claim to be a good city to invest in, but remember, you’re just trying to get a list started. You can dig into details later as you go along.
Start there. Make a list of what cities come up when you consider those two things. Again, this isn’t your final list, but at least your list is much shorter now than it was when it had all 19,354 U.S. cities on it as investing options. You may not have known you had a list of 19,354 cities on it, but if you were starting from scratch, the whole country was a possibility! That would have to be intimidating and overwhelming—and almost an impossible point to start from. Now you have a less intimidating starting point.
Step #2: Analyze Those Markets
So, now you are looking at your list of some number of cities or major markets on it, and now your question is—how do I know a good city to invest in from a bad city?
In my mind, there are only two major questions I ask to determine whether I want to invest in a particular city:
- Do the numbers work?
- How likely am I going to be able to sustain those numbers?
If you don’t know what numbers I’m talking about, I’m talking about your returns. Returns (a.k.a. profits) can happen in two major ways: cash flow and appreciation. This is at least true for rental properties. If you are flipping out-of-state, some of this will be different for you and there are some slightly different considerations that you’ll need to incorporate into your analyses. You’re on your own, though, for those, as I’ve never flipped so I definitely shouldn’t be the one to tell you how to rock that method out.
Most likely, if you are wanting to invest out-of-state, you’re probably doing so because you want cash flow. Most of the investors who invest out-of-state do so because the numbers locally don’t pencil out. This is often the case in a lot of the bigger markets—Los Angeles, San Francisco, New York, etc. And while those markets don’t usually pencil out for cash flow, they are the bigger players when it comes to appreciation. So, in thinking of anyone who lives there and wants to buy out-of-state, it’s probably because they want cash flow. See my logic?
Either way, let’s assume you are going after cash-flowing rental properties out-of-state because you can’t find cash flow locally. If that’s the case, the numbers need to work in the market you choose to invest in. Otherwise, what’s the point?
So, let’s think about the numbers. What kind of numbers do you need to understand when it comes to cash flow?
If you are in it for cash flow, you want to be able to determine the projected cash flow on a property. To help you do that, use the easy formulas in this article: “Rental Property Numbers so Easy You Can Calculate Them on a Napkin.”
In addition to the equations in that article, a term you will want to be familiar with is “price-to-rent ratio.” This term compares the price of a property to how much rent it can collect. The reason these two things matter is because they will determine whether you can cash flow on the property or not. As you saw in those cash flow equations, you need the rental income you collect on a property to surpass the expenses of buying and owning that property in order to have positive cash flow. If the expenses of buying and owning that property are higher than the rent you can collect from the property, you’re in a negative cash flow situation and losing money, on the cash flow front at least.
Knowing this term now, if someone asks you if you’re interested in a particular market for investing, your first question might be—how are the price-to-rent ratios there? What you’re ultimately asking here is—is there an option for cash flow in that particular city? For instance, I can tell you that hands-down the price-to-rent ratios in Los Angeles are not supportive of cash flow. I can tell you that the price-to-rent ratios in Indianapolis are generally favorable for cash flow. In no way does that mean every property or every location within Indianapolis will cash flow, but it does mean there is an option for it—whereas in Los Angeles, there’s really no option for cash flow.
Now, let’s say a particular market has generally favorable price-to-rent ratios for cash flow.
Oh wait, I just heard you ask—how do I know if a market has favorable price-to-rent ratios? Great question. The fastest way to find that out is to network with other investors. You can either ask other people where they are investing, which I already mentioned, or let’s say you have a family member in a particular city and you’re curious about whether or not you can cash flow there. Post in a BiggerPockets Forum and ask people if they have any knowledge of cash flow potential in said market. Look for people investing there, and find out the best places for cash flow there. If all of that fails, start looking up properties and running those equations I taught you and see if you’re coming out ahead on cash flow.
Let’s say a particular market has generally favorable price-to-rent ratios for cash flow. This is where that second question I asked comes in—how likely am I going to be able to sustain those numbers?
The answer to this question is lengthy, so I’ll just give you one basic thought to consider for now. Is the market you are looking at a growth market or a declining market? The reason this matters is because you can project cash flow numbers until the cows come home, but if certain factors come into play with your property, you may never see a single bit of that projected cash flow materialize. Bad tenants, for example, can cause you to not see a penny of your projected flow because they can cost so much in expenses, IF they are even paying the rent.
For details on growth versus declining markets and how to know what factors you can look at to determine which one your market of interest falls under, check out “How to Know If Any Given Real Estate Market is Wise to Invest in (With Real Life Examples!).”
To help you understand the potential consequences of investing in a declining market, check out “5 Risks of Buying Rental Properties in Declining Markets.”
Step #3: Decide on a Market
Your list of potential markets should be even shorter now than it was when you narrowed it down from 19,354 cities to either cities you know people in or have ties to or cities other investors recommend. Now your list should only include markets/cities that the numbers not only work in but also where the numbers have good potential of sustaining themselves. That last part is purely my own personal investment strategy preference—it’s certainly not a requirement.