The United States is one of the largest countries in the world, by any measure. It covers 3.797 million square miles, includes 19,505 incorporated towns, and has nearly 326 million residents.
So, how do you know where to buy a property as a real estate investor? Where are the best returns in the US real estate market?
Most investors never look much further beyond their own backyards, in the city where they live. Which is great, if you happen to live in a city with strong cap rates and rental returns.
But what if you don’t? What if you live in an exorbitantly priced coastal city?
These ratios help you narrow the list from hundreds of thousands of US neighborhoods down to dozens. But the price-to-rent ratio doesn’t tell you the whole story.
The 2% Rule & Hidden Costs
Many investors follow the “2% Rule” – they only buy income properties that rent for at least 2% of the purchase price. For them to consider buying a $100,000 rental property, it would have to rent for at least $2,000/month.
Those opportunities exist. I’ve bought properties that followed the 2% Rule. But nearly every single one ended up underperforming for me.
Why? What goes wrong?
The problem is that price and rent don’t tell you anything about the “hidden” costs of managing rentals in that neighborhood.
To illustrate this point, I’m going to share my experiences managing two of my own rental properties. Both are in Baltimore, both are brick rowhouses, both have three bedrooms and one bathroom.
But that’s where the similarities end.
One is on Fleet Street, in a neighborhood catering to young professionals. It cost me $150,000 and originally rented for $1,800 (it now rents for more). Original price-to-rent ratio: 6.9.
The other is on Francis Street, in a lower-end neighborhood. It cost me $50,000, and rents for $1,000. Price-to-rent ratio: 4.2.
On paper, Francis should be the far better investment. Here’s how it actually played out, and how hidden rental costs ended up affecting my return on investment in each case.
Fleet has never been vacant. I’ve managed to implement one-day turnovers, because rental demand is strong in the neighborhood.
Francis has sat vacant for three to four months at a time. Demand is far weaker in this neighborhood, and lowering the asking rent has only resulted in attracting lower-quality renters.
Before buying a rental property, do your due diligence on neighborhood vacancy rates. Local realtors can sometimes help provide these numbers.
Even better, talk to local property managers who service the neighborhood. They’ll be able to provide excellent first-hand impressions and data, to help you use a realistic vacancy rate when forecasting your cash flow figures.
Rent Defaults & Evictions
How commonly do renters stop paying the rent in this neighborhood? It’s a crucial question for rental investors to answer before investing a cent in real estate in this neighborhood.
Rent defaults and evictions in Fleet’s neighborhood are relatively rare. But Francis? Over the decade I owned my rental property there, it was more common for rents to be late than on time.
And that’s when they came in at all.
It was a constant battle to collect rent on Francis. The pattern of excuses, followed by eviction filing, followed by either last-minute payment or eviction became unbelievably tedious. Not to mention time-consuming, as I was constantly in and out of court, serving legal notices, and having to keep track of late fees and filing fees.
Because evictions are filed on a local level, and procedures vary across jurisdictions, it’s difficult to find accurate neighborhood-level eviction data. You can try Eviction Lab, but their data remains incomplete.
Like vacancy rates, the best way to gauge eviction rates and rent defaults in a neighborhood is to speak directly with property managers who service it.
Turnovers similarly wreak havoc on landlord returns.
How transient is the neighborhood? Do people move in for a year or two, then move on? Or do they set down roots and raise their children there?
In the case of Fleet and Francis, both see high turnover rates. Fleet is in a neighborhood catering to single, young professionals. They love the gritty-chic urban vibe of the neighborhood… for a year or two. Then they get married and move out to the suburbs.
Francis suffers turnovers for a different reason – evictions.
But without actually speaking to landlords or property managers in these two neighborhoods, how would you know? Like eviction rates, this data is simply not available online.
Property Damage and Wear & Tear
Some landlords refuse pets because of the potential damage and wear that they can cause. But I’ve personally found that damage varies more by neighborhood.
At Fleet, the renters have been respectful. They take care of the rental property. When they move out, they leave it spick and span, fully expecting their security deposit refund.
At Francis, I can only remember one tenant who received a security deposit refund. The rest left the property in shambles.
Once again, no data can tell you how respectful renters in a given neighborhood are. How they treat the homes in it. You need to talk to landlords and property managers on the ground in that neighborhood for insights.
Crime and Vandalism
Finally! A metric with accessible data.
Crime plays an enormous role, both directly and indirectly, on landlords’ return on investment. Indirectly, it impacts rents and turnover rates, spooking good renters away from the neighborhood. And directly, high-crime neighborhoods leave your property vulnerable to break-ins, theft, and vandalism.
Fleet has never been broken into and has never had a problem with vandalism. Francis has been broken into twice, and the copper tubing ripped from the air conditioning condenser. Now the property no longer has central air.
The Savvy Real Estate Investor’s Hunt for New Markets
What are the odds that you happen to live in the perfect neighborhood, or even the perfect city, for rental investing?
Part of your success as a real estate investor (especially as a rental investor!) depends on your ability to identify new markets. Markets that you’re not familiar with, but which are ideal for cash flowing rental properties.
That search for new markets starts with neighborhood-level property investing data. Pricing data, rent data, cap rates, crime data. How do Airbnb profits compare to long-term rental profits? What kind of occupancy rates do Airbnb rentals see in the neighborhood? Is Airbnb a viable option in this market, or do long-term rentals perform better?
Your market research begins with that data – but it doesn’t end there.
As you narrow your search to a handful of new markets to invest in, put your feelers out among local landlords and property managers. Ask questions about the kinds of tenants who live there. How long they stay. How often they default on rents. How often the rental units turn over.
Start with quantitative data, then increasingly start gathering qualitative data. If cap rates and price-to-rent ratios will help you narrow your list of prospective neighborhoods for rental investing, it’s the qualitative data that will help you choose the best among your shortlisted markets.
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What have your experiences been with the 2% Rule? What hidden rental expenses do you make sure you research before buying? Share your experiences below!