Due Diligence for Investing Out of State

For those who live in expensive real estate markets, buying out-of-state in a cash flow market can look very appealing. On the one hand, it makes perfect sense because in certain places, such as California or New York, real estate simply costs too much to rent out and make it pencil out. However, investing out-of-state is very risky and I have seen a lot of equity go the way of the dodo bird when investors buy real estate far from home.

I met one man who 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 flew out and found that both properties hadn’t even been touched. I know another guy who got stuck with a 50 unit complex that took three years and three managers to turn around. Another lost two apartments to foreclosure. Another had to move and take over the apartment himself to finally get it to perform. The list goes on…

Needless to say, unless you own an investment company specifically designed to be national in scope, out-of-state investing is something to be extremely careful about. If you do want to risk it, here are some mandatory steps.

Investigate the Team

This is always important, but exponentially more so when buying out-of-state. Ask around to get a referral on a property manager. Then interview them thoroughly, ask for references and interview those references thoroughly. Do the same with any contractors and vendors you use. 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 unfortunately, not every one of them will overcome such temptations.

It is also a good idea to visit from time to time to keep the managers accountable and make sure everything is in good working order. 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.

Investigate the Area

Some bad areas can be deceiving even when you are there in person. And Google Earth has a way of making even terrible neighborhoods look OK. The stereotype is that these areas will visually appear to be 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 such as the following:

• City-data.com – This site is great and has all sorts of information about the city and the zip code. It also has a map feature that can break down income and other demographic information (although unfortunately not crime) by subdivision.
• CLRSearch.com – This site can give you crime data as well as a lot more for any zip code.
• Homefair.com – Similar to CLRSearch.
• CrimeReports.com – I’m not a huge fan of crime mapping sites because I am quite confident they have incomplete data. But this is the best one I’ve found and it is worth looking at.

Evaluating the area is crucial. You absolutely do not want to own a property several states away in the middle of a war zone. The copper and A/C compressor 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 are very few management companies equipped to handle these types of properties.

Investigate the Property

Many people who live in 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! Just because you live in an area where houses go for $500,000, doesn’t mean that a house halfway across the country going for $50,000 is a good deal. Similar houses there may normally go for only $40,000 or even less.

And again, these properties may be 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 get a second opinion).

Also analyze the property yourself. Zillow.com is a good place to start, although 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 them to your prospective property. 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 upper, do not trust a seller’s repair estimates. It is almost always too low and usually way too low. 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 most are) it’s usually low because people are overly optimistic and don’t account for all sorts of things.

It is definitely a good idea to look at the house yourself even if that means flying out to do it. In addition, make sure to get a contractor bid on the repairs. 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.

Buyer Beware

Due diligence is always important, but when investing out-of-state, it becomes exponentially more so. I would personally 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.