How to Purchase Property in Other Markets | PREI 016
Have you ever asked how do you purchase property in other markets or out-of-state? Well there is a clearly defined method that works every time. It has been refined over the years and in this episode we break down that process into phases and talk about each one.
Some of the topics we discuss include:
- Selecting a market.
- Selecting a neighborhood and property.
- Doing your due diligence.
- Financing your purchase.
- The closing process.
- What to do post-closing.
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How to Purchase Property in Other Markets
Welcome to Passive Real Estate Investing episode sixteen. I’m your host, Marco Santarelli. Welcome. Thanks for joining us again. Today’s show is about how to purchase property out of state or out of your area or in another market. It’s what I’ve developed over the years and I call it the purchase process checklist. Essentially, I started investing out of state from California in three different states back in 2004. I was buying up a lot of property in a very short period of time.
That process was not something that I knew exactly how to do from day one. It was a process that I learned very quickly. Through that process, I made a lot of mistakes, I did lose some money. But I also learned how to properly, quickly and efficiently identify investment opportunities, put them under contract, do my due diligence pre contract, post contract and get to a close.
Although there’s no rocket science in this process, it is important to understand. Because a lot of investors find this process to be somewhat foreign, especially if you haven’t done it once or twice. Knowing what to look for and how to purchase property out of state or out of your local area is very important if you want to be successful. Because the truth is, a lot of people live in markets that are inflated and overpriced. The numbers just don’t make sense there. For example, coastal markets like in California, New York, New Jersey. The rent to value ratios there are so low, they might be .5%, .4%, .3%. The numbers just don’t make sense.
On top of that, those property values are so high that your investment capital, which is limited, will only go so far. When you look outside of your local market, you will find markets that are probably better off economically, have better opportunities, more choice for good quality income property. You’ll find that your cash on cash returns are higher and your overall down payment will be lower, which means that you can take your fixed amount of down payment capital and leverage that into a larger real estate portfolio, meaning that you can purchase more properties than you could locally.
Let’s start with basically phase number one, that is select your market. Once you know what your investment strategy is and you’ve detailed out your investment criteria, then you can narrow down the markets that meet your strategy and criteria. In other words, there’s over 400 markets in the US. You can’t be in all those markets. It’s also very difficult to know where to start. If you define your investment criteria, then you can eliminate majority of those markets and focus on certain ones. Obviously, we have our favorites. Within our company, we focus on about eight or nine different markets for various reasons, but they’re all really good markets.
If you focus on maximizing your cash flow, then the markets you want to focus on are the ones that’ll provide you higher rent to value ratios. These are typically what I call linear markets. Those are usually found in the midwest and parts of the southeast. If you want to understand linear and cyclical markets a little better, go back and listen to episode number six.
If your focus is to maximize your appreciation potential, then you’ll want to focus on more cyclical markets where prices are still undervalued relative to their historical mean and offer greater upside or greater appreciation potential. These are going to be markets that are typically experiencing very rapid growth. They’ll have lots of jobs and job growth and they’ll have a very strong growth in its population, meaning that there are a lot of people moving into that market.
Take the Texas markets like Dallas, Houston and San Antonio. There, we’re seeing a tremendous amount of growth in its population. A lot of these people are flowing in from other states, particularly California, because real estate is cheaper, the cost of living is cheaper, there are a lot of jobs. These markets are attracting in a lot of people. That is increasing the demand in these local markets for real estate and for rentals. That, therefore, pushes prices up.
The bottom line here is to select sound housing markets and those with good economies. You want a market, like I said, with job growth, preferably with positive in-migration and that is ideally, landlord friendly. Many states offer landlords the ability to quickly and easily evict problem tenants should that situation arise as opposed to other markets like certain states that will create a more challenging and longer term eviction process.
The second phase is to select your property. You do that by considering various neighborhood and property combinations. After doing your research and deciding on a particular market, now you want to start creating a shortlist of properties and doing some due diligence on various property and neighborhood combinations. It’s important to stick to your criteria. If you want to stick to premium A grade neighborhoods, then look at those types of properties. If you are after more of the bread and butter housing in the B type neighborhoods, then stick to that criteria. This will give you the best balance between cash flow, cap rate and appreciation potential. Finally, if you are a more aggressive, high cash flow type investor, then you might want to focus on C type neighborhoods. That’s not for everybody. I’d like to stick to the A and B type neighborhoods because I find that they’re going to give me the most stable investment.
Once you know your criteria, you can move forward and start looking at properties. If you’re working with a turnkey provider or a real estate brokerage, maybe you can get a shortlist from them so it won’t take you very long to actually get a list to evaluate. If you’re shooting darts in the dark and you’re looking on the MLS or you’re on the internet looking at websites like Zillow and Trulia and whatnot, it might take you a lot longer to sift through dozens, if not hundreds of properties to find candidates that meet your criteria.
You want to look at five key things. First and foremost is the condition. Ideally, you want to choose properties that are new or newly renovated. In other words, you want them to be more than just rent ready. You want them to be like new because you don’t want to inherit deferred maintenance or maintenance issues right away or within the first few years. Things could happen, but you want to avoid having serious problems, whether it’d be with the roof, the foundation, the mechanicals in the property. The condition is very important because you don’t want to walk into a deferred maintenance situation.
Second, you want to consider price. This is usually a function of the neighborhood. The focus is on the metrics such as cap rate, cash on cash return and rent to value ratio. Price is important in two ways. One, it’s important relative to the median price of that market. Are you purchasing above or below the median price? I like to stay near or below that median price. If you’re above the median price, often you’ll find yourself in better neighborhoods, what I’ll call premium neighborhoods. There’s nothing wrong with that. What you’ll find is that as you get into higher priced properties, your rates of return will drop off rather quickly in some cases.
Next, you want to look at the cap rate. This will vary by market and it’ll certainly vary from neighborhood to neighborhood within a given market. Ideally, you want to have a cap rate, or capitalization rate, over 8%. The key thing here is you want your cap rate to be higher than your mortgage interest rate. But even if it isn’t, you still want properties with a cap rate of 8% or higher.
Next, consider the cash on cash return of these properties you’re looking at. Same as the cap rate but with financing factored in. Your cash on cash return could easily be in the double digits, in the teens or even the 20% plus range with leverage. If you have 20% down or 25% down on a property, you will find your cash on cash return will jump up by a factor of two to three times or more.
Then you want to consider the rent to value ratio. Again, this is just a quick metric, it’s a litmus test. Ideally, you want to see that rent to value ratio be 1% or more. You never want it to be below .7%. Over 1% is a great situation.
As part of your due diligence, you want to review the details of the property. This includes the scope of work, if it was a newly renovated property. Sometimes this is referred to as the contractor’s list or the punch list. It’s essentially a list of what has been fixed, replaced and upgraded on the property. This will give you a good idea of the condition of that property. When you go and do a home inspection, you can verify that those things were done as well as you can see what you will not need to worry about in that property for the foreseeable future.
Also, you want to review the exterior and interior photos to get a good idea of the condition and the layout of the property. Again, this is just part of your due diligence. It’s not to see if you would live there or not, because keep in mind that a lot of properties are very desirable and will be leased all the time but they may not be to your personal taste or preferences.
The action items here are to do your due diligence, research properties, create a shortlist and narrow it down to the point where you can put a property or two under contract. Once you have that property under contract with a purchase and sale agreement, then you can send in your escrow deposit or what is known as a good faith deposit to the title company or closing attorney in some states. That will open escrow for you so you can now go to the next step in purchasing that property.
The next major phase is what I’ll call the due diligence phase. Everything you’ve done up to this point would be considered initial due diligence. After you select your property and put it under contract, you want to finish or continue doing your due diligence. This may involve visiting the property and the neighborhood and meeting with the team that you’re working with on the ground. I can tell you statistically that with our clients at Norada Real Estate, only one in 20 or about 5% of our clients actually get in a car or jump on a plane and fly down and meet with our team, tour the neighborhoods, visit the properties that we have for sale or maybe the specific property that they have under contract.
That’s a small percentage but the reality is, it is so easy to do your due diligence remotely today, especially with internet based tools such as email, being able to send digital photos and videos, having Google Maps and Google Streetview and a whole slew of research websites, whether it’d be Zillow, Trulia, NeighborhoodScout, City-Data. There’s just a ton of different websites. You can do a lot of this armchair investing and do your due diligence from your kitchen table with the help of the people that you work with, over the phone and over the internet. It’s just amazing.
We do encourage our clients to go out and visit the site and meet with our team. We find that they get a lot of value from that. It’s not mandatory. One of the first things you want to do after you’ve put the property under contract is order your home inspection. We recommend ordering a third party home inspection just to make sure there are no major issues at the property.
When it comes to inspections, I look at that inspection report when it comes back and break it into three major categories: must be done items, should be done items and could be done items. The reality is that if you are looking at a new construction property or a newly refurbished property, there’s going to be very little to no issues with that property but there will always be a laundry list of small minor items. This is why I break it up into these three categories.
What you’re looking for are major items, red flags, things that I call must be done. Hopefully, there won’t be any of those. Usually, there aren’t. There may be some subjective things that are questionable or a matter of just having conversation on should be done items. You’ll always find a list of things that I’ll categorize as could be done. This could be paint scratches, just normal wear and tear, things that are somewhat minor and trivial that really don’t affect the property materially or its livability or its appeal to a tenant. It’s still just as rentable with or without.
The cost of these inspections will vary depending on the size of the property and the market you’re in. They’ll usually vary from $200 to $500 per unit, per door. If you’re buying a single family detached home, you’ll probably be in the neighborhood of about $300, plus or minus $50. If you’re purchasing a duplex or a fourplex, then that number can go up quite quickly to $600, $800 depending on how many units are being inspected.
Again, you want to have a home inspection done so you can make sure that there are no issues with the property and feel good about the purchase. If there are any major items, then that could be worked out, you can cancel your contract, move on to another property. Or you can just have the seller who is responsible for that property, go back and cure the problem.
The second thing you want to do as far as an action item with due diligence is talk to the property manager. This is very important. You can do this in the previous phase when you’re selecting a property. Because if you have a shortlist or you’ve just narrowed it down to one property, you can talk to the property manager to get a better feel for the existing tenants. They’re not going to tell you specifics about their income or maybe where they work, but they can give you a pretty good feel about their stability and how well qualified they are.
If the property is vacant, then they can tell you about the target rent and the type of tenant that they’re looking for. They’ll tell you about their services, the fees they charge, what they do charge you for and what they don’t charge you for. They can answer all your questions as well as give you an idea of how that communication and workflow will be, how they’re going to pay you, whether it’s direct deposit into your account or whether they’re just going to print you a check and mail it to you.
The important thing is that you want to have a good relationship with your property manager, you want to have trust, you want to be able to work with them because they’re essentially working for you. They’re your eyes and ears. I refer to them as your asset manager, not just your property manager. You want that warm and fuzzy feeling in your belly with working with them. If you don’t have that, then you want to work with a different property manager because at the end of the day, I like to say you live and die by your property manager. It is very important that you have the right team working with you.
Optionally, you can talk to the builder or the rehabber as part of your due diligence. Not everybody does this. I certainly encourage it but it’s not something that is critical. If you talk to the builder or the rehabber, you can get a better feel for the location, the neighborhood, the amenities from their perspective. As well as they can answer any questions you have about the property related to the scope of work, the property itself, any history that they have on the property. It’s just another item.
If you’re working with a real estate agent or going through a real estate brokerage, many times this is actually not possible. Not that it’s impossible, it’s just that most real estate agents want you to work with them and through them in communicating with the seller’s agent or brokerage.
With us, we have a direct model. If you want to talk to our team within our network, our builders and our rehabbers, that is not a problem. We put you on the phone right away with them so you can have a good dialogue and find out more about that property and what’s being done or what has been done.
The next phase is financing. This is not a phase that happens after your due diligence. It happens in tandem and runs in parallel with your due diligence. If you’re financing your property, then you’ll want to work closely with your loan officer. It’s important that you communicate with them and get them everything they need in order to continue putting your file together, in order to submit that into underwriting.
One of the first things they’ll do is order an appraisal. The appraisal is typically done first and it takes about a week, plus or minus. That appraisal is usually prepaid by you and that could cost anywhere from $300 to $500, depending on who you’re working with. That appraisal is one of the first steps on the financing side. In addition to that, you’ll want to send all the requested documents to your loan officer as soon as possible because they’re going to need that in order to complete the files.
Once the appraisal comes back, they can package that up and submit that into underwriting. Once it’s in underwriting, it’s just a waiting game. They may request more documents from you. If they do, which happens from time to time, you want to get those back to the loan officer so they can get that filed back into underwriting and continue with the process.
Financing typically takes about 30 days, plus or minus. That is a good number to work with. The reality is, financing can be done in as little as three weeks but I’ve seen it take as many as six weeks. One of the biggest variables, believe it or not, is actually the borrower. The faster you can get the information to your loan officer and just stay on top of your loan officer to make sure that they’re following through and getting everything done for you, the sooner you’ll have your financing in place and the sooner you’ll be able to close.
I suggest with financing that you actually have your preapproval in place before you actually start shopping for a property. By having the preapproval in your pocket, you have essentially your gun loaded. That means, you can go out and you know what you can afford in terms of what you can finance. Once you have that property and you have it under contract, you can immediately submit that purchase agreement to your loan officer and have your financing started immediately without having to wait for you to start submitting your documentation over to them after the property’s under contract.
The next phase is the closing phase. The closing process involves signing various documents that are going to be included in your closing package. Some of the documents will require a signature from a notary, which means that they’re basically witnessing your signature. This is especially true if you’re financing your property because whenever you finance your property, you’re going to have mortgage documents and those mortgage documents will require the signature of a notary along with your signature. They’re going to witness your signature and see that you are who you say you are by recording you in a book and verifying that with picture ID.
The closing package is a set of documents. That can be sent to you by email or via overnight delivery. Depending on what’s included and whether you’re financing it or not, sometimes it’ll be sent to you with a FedEx or UPS package.
The important thing here is that time is of the essence. The signed closing documents must be returned by the closing date. This is very important because the settlement statement that comes in that closing package, all the numbers that are calculated on that are calculated based on a closing date. If you get that package and you wire back to them later, then that changes those numbers.
The action items here are to review, sign and return the documents within that closing package on or before the closing date. In conjunction with that, you want to wire or overnight certified funds to the title company that is doing the closing. Again, that has to go with your closing package and be there on or before the closing date.
Once you do that, the title company can wrap up the closing and transfer title to you. At that point, you are officially the new owner of that property. At this point, you can pat yourself on the back for adding another property to your real estate portfolio. You just simply rinse and repeat, do it again.
What may be called a post closing phase is made up of a few things. Shortly after the close, you will receive a recorded copy of your new deed to the property. File this for safekeeping. If you haven’t done so already, the next thing you want to do is sign a new agreement with your property manager. You want to have a management agreement in place, which you would’ve received, read through, reviewed, questioned if necessary and then signed and sent back.
This is a critical document because it basically gives your property manager the authority to manage your property on your behalf and to pay for expenses that come up with or without your authorization. Usually, there’s a threshold as to how much they can spend without your authorization. That could be $250, $300, $500. You set that limit. All your fees are outlined in that agreement.
My suggestion is if you can, take care of the management agreement a few weeks before you actually close. They can’t manage the property for you yet but at least you have that management agreement reviewed, signed and on file so they can take over the next day.
Also, you want to confirm that your property manager has all that proper contact information for you. You’ll be putting that in the management agreement, but my suggestion is to actually have a call with them right after you close just to let them know, “I’ve closed, what’s the next step?” Often, there’s not much to do if you have a management agreement already in place.
Going forward, you’ll want to contact your property manager, whether by phone and/or email from time to time just to help continue to build that professional relationship with them. Again, you want to have that relationship with them. They’re working for you, consider yourself the CEO of your company and your property manager is your middle management. You want to keep your thumb on the pulse of what’s going on.
Many property management companies will actually have an online portal where you can login and see all the activity and the notes that apply to your property every month and every day or every week. The accounting is all there, you may not need to be calling them at all. That information will be available to you.
One thing I forgot to mention in tandem with the financing and due diligence is you’ll also want to shop around for property insurance. You’ll want to have a quote and a declaration page that you can send over to your lender. They will put that on the settlement statement and include as part of your closing, especially if they’re going to escrow the insurance payments for you.
If you purchased your property all cash, nobody would’ve asked you for a proof of insurance or for a quote. At this point, you definitely want to contact your insurance agent and get a policy in place right away because you don’t want that property sitting on your books without proper coverage or liability insurance.
Keep in mind that this purchase process that I went through with you is not meant to be a complete and comprehensive overview. Every real estate investor’s personal situation will be somewhat different and unique. Therefore, every transaction will be slightly different and unique. This is a 20,000 foot view of each phase and what you’ll need to do in each of those phases.
Once you’ve gone through this process once or twice, you’ll find that it becomes infinitely easier because there is no magic or rocket science. This is pure logic, step by step as far as how you do your due diligence, identify properties, put them under contract, go through closing, take care of the management piece and close to add another property to your portfolio.
We’ve got this system down to a science and it’s actually a little bit more involved in what I’ve just outlined with you. Again, we take it on a case by case basis with each and every client. Hopefully, this was helpful. If you have any questions, give one of our investment counselors a call. We can walk you through this a little bit more in detail. It is pretty straightforward. We’re always happy to help.
That about wraps it up. Don’t forget to download our free report, The Ultimate Guide to Passive Real Estate Investing. You can find that on our website, PassiveRealEstateInvesting.com. If you have any questions or topic suggestions, please do submit those via our contact form. We also have a voicemail system on our website. You can click a button and record a message and it’ll be sent directly to me. Please remember to subscribe. If you’re listening to this for the first time on our website or just found one of the episodes, we put out content every week so subscribe and enjoy the future content episodes we have.
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