Coming from the West Coast to the Midwest, I've seen both sides of investing out-of-state. On the one hand, it makes perfect sense because in certain places, such as California or New York, real estate is too expensive to rent out and make it pencil. However, investing out-of-state is very risky and I have seen a lot of equity go the way of the dinosaur when buying real estate far away.
One memory in particular springs to mind of a man who stopped by our office to ask if we managed properties. He had bought two houses out-of-state at highly inflated prices from an extremely shady individual and then paid them more to do the rehab. When they stopped returning his calls he came out to Kansas City and found that both properties hadn't even been touched. I have rarely seen someone look so defeated, and telling him there was nothing we could do was a very unpleasant task indeed.
I know another guy who got stuck with a 50 unit complex that took 3 years and 3 managers to turn around. Another lost two apartments to foreclosure. Another had to move out here to finally get his apartment to perform. The list goes on…
Needless to say, unless you own an investment company that is designed to be national in scope, out-of-state investing is something I would shy away from. If you do want to risk it, here are some key things to do.
Vet the Team
Regardless of where you are, you need to do vet your team, but even more so when buying out-of-state. Ask around to find a property manager, interview them thoroughly, ask for references and interview those references thoroughly as well. Do the same with any contractors you use. From what I've seen, it's usually unwise to have the same company that you bought the property from do the rehab. It is a conflict of interest and not all will overcome such temptations. And make sure to visit from time to time to keep the managers accountable and make sure everything looks right. Finally, do not be afraid to switch management companies if they are not getting the job done!
Remember, most properties fail because of bad management.
Vet the Property
Many people from high priced markets are so blown away by the price difference and potential return (key word: potential) in cash flow markets that they assume they must be getting a good deal. Make no such assumption! These properties are often in the middle of a war zone and the potential return might as well be a bunch of made up numbers. If they tell you the cap rate is over 20, trust me, it’s made up. So call a realtor or two to get a CMA or their advice on these areas (or a different realtor if you are working with a realtor already just to be sure).
Also analyze the property yourself. Zillow.com is a good place to start, but remember the Zestimate is usually high and almost always wrong. Same goes for EAppraisal. Look for the nearby sale comps on their map feature and compare that to your prospective property. Don't just look at whatever value some algorithm blurted out. In addition, look at the rents. Rentometer is a fine place to begin, but real comps are better. Hotpads and Craigslist both have map features now that allow users to easily find comparables. If there is a tenant, make sure to get an updated rent roll, a certificate of deposit (to make sure the rent roll is accurate) and preferably (although you'll need the tenants permission) a copy of the tenants' background report.
If you are buying a fixer, do not trust a seller's repair estimates, it's almost always more and usually a lot more. It's not uncommon for me to triple a seller’s repair estimate when doing the estimate myself. Even when sellers are trying to be honest (and yes, most are honest) it's usually low because people are overly optimistic and don’t account for all sorts of things. I have seen a lot of things go over budget, but very few come in under. The Sydney Opera House was supposed to cost $7 million but ended up costing over $100 million! Look at the property in person yourself and try to get a contractor bid or at least rough estimate. And remember, that bid will usually not include appliances, HVAC, carpet, cleaning and other such things. There will also probably be a few change orders and add-ons, so include an unforeseen allowance in your repair estimate.
Vet the Area
Some bad areas can be deceiving even when you are there in person. The movies make these areas appear completely hopeless, and some are, but some do not look that bad on the surface. Make sure to ask the neighbors how they like the neighborhood. Ask some local professionals what they think of that area as well. And research the area with websites that have crime and income data. City-data.com has a map feature that can break income and other demographics (although unfortunately not crime) by subdivision. And CLRSearch.com and Homefair.com have zip code crime data. I'm not a huge fan of the crime mapping sites, such as CrimeReports.com, because I am quite confident they have incomplete data. But either way, be thorough in researching the area.
Do not skip this step; you absolutely do not want to own a property several states away in the middle of a war zone. The A/C will get stolen, evictions will be common and tenants will often trash the house on the way out. The rent (when it comes in) will rarely cover the turnover and rehab. To make money in these areas, you really have to specialize in it. I’ve seen it done, but there isn't a manager on Earth I would trust in really rough areas to manage my properties.
Due diligence is always important, but when investing out-of-state, it becomes exponentially more so. Again, I recommend staying close to home unless you have an operation designed for out-of-state investing. However, if you choose to risk it, make sure to be extremely diligent.