To build an out-of-state real estate portfolio, the first thing you need to do is identify potential rental investment markets to evaluate more closely. In the future, I’ll dedicate a post to detail my full investing philosophy and rationale. For now i’ve listed the 3 key factors that I look for to identify the “perfect” rental investment market.
3 Key Criteria for the Perfect Rental Investment Market
- Stable Rental Investment Market: My strategy doesn’t rely on significant price appreciation. However, I do need confidence that I am investing in markets where I can reliably forecast the rent and vacancy levels. I think rent affordability (median income/rent) is one of the best factors to determine the relative stability of the rental market. In addition, you should consider population growth and job growth.
- Experienced Local Partners: I need one or more partners who can reliably source and screen properties that will meet my criteria. I also need partners to manage any rehab and repairs, screen and place a quality tenant, and handle ongoing management.
- Above Average Rental Returns: This is where I start to narrow my search. For out-of-state investing to be worthwhile you need to be able to achieve attractive returns. For me those returns need to be well in excess of what is achievable in the stock market. It’s interesting that the average rental return in the US is ~8%, which is about what I would expect to earn from a diversified stock portfolio over time.
Best Investment Markets in the U.S.
Here I started with 35 of the largest metro areas. I then used data available on Zillow to approximate the average home sale price and monthly rent. From my experience Zillow numbers can sometime be misleading (particularly for market rent levels). Directionally though, this should be helpful to identify a rental investment market with high return potential.
Not surprisingly New York City and many of the California markets don’t fare very well with this type of evaluation. The sale prices are way too high without a corresponding increase in the typical rental rates. These markets often make up for lower rental returns with the potential for above-average price appreciation. In this case, that is not a core focus of my initial strategy. There also could be particular cities and neighborhoods in some of these higher cost metro areas that offer more attractive buy-and-hold rental metrics. However, for efficiency I will use the below high-level analysis as an initial filter. I have highlighted the seven markets with indicative returns above 10%. I start my search by evaluating these markets first.
Rental Investment Markets with Above Average Returns (Based on 35 Largest Areas)
- Includes large metro areas with rental returns above the US average
- Median home values and rent taken from Zillow as of June 2016
- Rent to Price based on Monthly Median Rent divided by Median Home Value
- All Returns are based on the 50% rule (assumes Taxes, Insurance, Property Management, Vacancy, Maintenance, and Other Expenses are covered by 50% of the annual gross rent)
- 75% Financed Returns assume that 75% of the purchase price is financed at 5% with a 30% effective tax rate (3.5% after-tax)
Markets like Atlanta, Chicago, and Miami will also present compelling opportunities. For those markets you need to dig further down to individual cities and neighborhoods. Check out my Neighborhood Guides which breakdown several large metro areas by zip code. In each metro area guide I identify the best rental investment market by zip code.
Have you invested in any of the above markets? I’d love to hear what you think. Let me know if there are any particular cities that you think I should focus on in my next post.