TBT: Ask Marco – Real Estate Newbie! What Properties and Markets for a First Time Investor?

Hello my friends. Welcome back to Passive Real Estate Investing where we dive into the world of real estate investing among other related topics. To help you with your real estate investing journey, today we’re doing something a little different. We’re going to take a trip down memory lane and showcase an important episode from the past on what we call our throwback Thursday episode. Now, whether you’ve been with us since the beginning, which goes back to 2015, or you’re tuning in for the first time, this episode is a must listen, we are revisiting one of our more popular episodes from the past, and believe me, what we discussed back then, whether it’s six months ago or six years ago, is just as relevant today. So sit back, relax, and let’s rewind the clock for this great episode. Enjoy.

Today’s question comes from Philip and he says, hi Marco. My name is Phillip from Southern California. I’m a millennial that is looking to create serious passive income through rentals. What kind of properties and what city would you recommend to invest for first-timers in real estate? Investing like myself, especially in these strange times. Thank you for providing us educational and informational content every week! – Philip.

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Throwback Thursday Episode (The episode originally took place in the year 2020)

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Well, Philip, thank you for your question. It’s a good one. There’s a lot of new investors out there. Some of them just call themselves newbies, but we all start with our first property and we all start at someplace in the beginning. And you living in Southern California are in an unfortunate circumstance being surrounded by very expensive property. So from that perspective, it doesn’t make sense to invest in your backyard.

However, good news. The good news is is that this is a very large country made up of over 500 metropolitan statistical areas or what is known as an MSA. And because of that, you have the ability to invest in any of those markets. Pretty much anytime you want, the question is what market and what are you looking for? And I think that’s the basis of your question here is you’re asking what kind of properties and what kind of market or cities should I invest in. And you’re a first-time real estate investor. So you want to start off on the right footing and not make mistakes, or at least not costly mistakes in the beginning, but you want to have success and that’s not hard to do just follow a simple formula.

And so here’s the formula and it really is a top-down approach. Think of it like a funnel. In fact, I talk about this in my 10 rules of successful real estate investing. And I believe it’s rule number six, which is taking a top-down approach. So what do you want to do is not start with a property, although that is important, but you want to start with the market. So you want to find a market or look for a market or have someone help you find a market, decide on a market that is healthy. It has good fundamentals. In other words, you want to market that is not in decline. You want a market that has population growth and at the heart of it, all our jobs and job growth. If you have a healthy, vibrant economy in a local market, then you will have jobs and probably job growth. That job growth means that more people will move into that market and the population will grow and that increases demand.

And that drives the market up in terms of price. And even if it doesn’t go up in price, you have that stability, that upward pressure, because people need a place to live, whether they’re buying it or renting it. So at the heart of it, all our jobs and job growth population growth is great. Organic is there ideally, but if you have people coming in from the outside, then you have net migration, positive migration that helps the market. And that just helps you. Now keep in mind, a lot of the markets are pretty big and you start to need to look at submarkets neighborhoods within those. And that’s the funnel approach. So you start with the market, work your way down to the neighborhoods, and then the property. One more comment about markets that I want to just throw out there.

There are three general types of markets that we classify there. The tier one, two and three, uh, we don’t typically use that terminology all that much, but a tier-one market is the big market like San Francisco, Los Angeles, New York, and often those very large markets tend to be overpriced, maybe not everywhere within that metropolitan area, but many parts of it. So where are you going to find the numbers, making sense and still have a diverse economy and a healthy market and a lot of supply and or demand driving the market one way or the other are in the tier two markets. These are markets that are typically in the hundreds of thousands in population to a couple of million. So Kansas City, Missouri, Indianapolis, Indiana, Jacksonville, Florida, Houston, Texas, although Houston is a very large area, broken down into different sections. Generally speaking, these are markets that I would consider tier two. Now the tertiary markets are much smaller, smaller populations, not always, but often are below a hundred thousand and they can make very good markets too because they tend to be bedroom communities or feeder markets off of larger markets. Like the tier two markets like Indianapolis and what not. Okay.

So enough about markets just choose a market that has a healthy, vibrant economy, strong fundamentals. And if you can see jobs and job growth, they’re great. Move forward. Now, neighborhoods, this is critically important. In fact, if I had to choose between a high-quality neighborhood and a high-quality market, I would go with a high-quality neighborhood. And the reason is this, every single market around the country is going to have your premium, great neighborhoods, your terrible neighborhoods that you might call the hood and everything in between. So every single city or market is going to have every type of person you can think of different income brackets, different demographics, different everything. So if you’re focused on one thing, focus on a great neighborhood, the best you can afford. And that doesn’t mean being in an A-plus neighborhood premium high-end luxury neighborhood because the numbers won’t make sense in that neighborhood.

What you actually need is a neighborhood that gives you a strong tenant base that has a good-paying job that has predictable income. These are typically your good blue-collar and upper blue-collar jobs. Maybe you’re lower white-collar type employment, which are professionals, young professionals, etcetera. They tend to be pretty reliable and consistent. So there’s the predictability of income and therefore predictability of rent. So neighborhoods are, to me, one of the most important variables in this whole formula. So I loosely say that I like to stick to B class neighborhoods, B plus, and A-minus neighborhoods. These give you kind of the best bang for the buck. It’s a good balance between quality neighborhood, low crime, decent schools, strong employment, decent appreciation, or appreciation potential while at the same time, giving you positive cash flow and a decent rate of return or cash on cash return.

So when you have cash flow in the cash on cash return and you have stability in the market and the potential for future price appreciation, you kind of have a hybrid neighborhood. You got the best of both worlds. If you swing to C class neighborhoods, you’re going to have very attractive looking cash on cash returns, but you’re giving up on that appreciation potential. If you focus on more premium type neighborhoods, kind of the, not the high-end luxury, but the nicer definitely your white-collar professional type neighborhoods, I would put that kind of the second quintile of your housing stock in the market. Those types of neighborhoods will tend to see very good appreciation over the long term, but they suffer for the most part in terms of having attractive or sexy cash on cash returns.

Okay. So lastly is the property stick to properties that are quality properties in good condition, either new or like new, most of the time, you’re going to be looking at properties that are newly renovated and, or like new, not necessarily new construction, although we’re seeing more and more new construction coming out. And so you just want to avoid properties that have maintenance issues that need immediate repairs or have deferred maintenance items, especially expensive items, which we call CAPEX – capital expenditures. So you don’t want to be acquiring a property that is going to need a new roof in three years or has a very, very old hot water tank or very, very old furnace or HVAC system. So you want to stick to properties that are sound in terms of that mechanicals and in good condition in terms of everything else, which I just chalk up to be the cosmetics of the property at the end of the day, your property needs to be safe, clean, and functional, no deferred maintenance, but safe, clean and functional. So that’s the market, the neighborhood, the property. Now, of course, it goes without saying, but I’m going to mention it. You want positive cashflow the more, the better, but keep in mind that you need to have the other pieces of the puzzle place. You need to check the boxes here when you have decent cashflow and decent is not an objective figure. It is somewhat subjective, but generally speaking, if you’re investing in a property with the maximum down payment, well, I should say the minimum down payment maximum leverage, let’s call that 20% down. And you’re in generally speaking a, B or B plus neighborhood in a particular market, you should be looking at receiving anywhere from $200 to $300 per month per door, after budgeting for vacancy and after budgeting for maintenance and repairs. Now that number might be a little bit lower with new construction because you don’t stand to see any kind of CAPEX, maintenance or repairs for a long time. So you can almost wash those out. Not necessarily entirely. You still want to start budgeting for it down the road, but when you start taking out those numbers or light in those, those numbers, in terms of vacancy allowance and maintenance and repairs, you see your cash flows go back up.

I’ve seen properties anywhere from $150 to $450 per month per door. Again, it depends on the market, depends more specifically on the neighborhood. But if you are in that two to $300 per month, positive cashflow net, true net, you’re off to the races because that will grow higher in time. Last but not least, you didn’t ask this, but I’m going to throw it in there as the fifth part of this formula. And that is the right team, the right acquisition person, the right property manager, critically important property management is a key piece. Your financing and lending partners, your asset protection attorney, and your tax advisor, all important people on your team. Of course, as you know, we can help you with all of those elements. We’ve pretty much-covered everything you need for this entire formula. So you can do it on your own. It takes a little extra effort and work and some diligence and research, but you can assemble all these pieces together yourself.

In wrapping up your question there, Phillip, my biggest piece of advice in this, a mistake I made in the past is just, don’t think that as a new investor, you need to start small or dip your tone of water or start slow. I mean, I can come up with all these sayings that I’ve heard from new investors that are just getting started and it’s their first or second property. They think that starting slow, starting smaller, being cautious means a cheaper priced property. No, definitely not. Do not think that you are doing yourself a favor by focusing on a 60, $50,000, $70,000 property. When you can just spend a little bit more on down payment and focus on a 9,000, $110,000 property, maybe $130,000 property, depending on the market. Of course, you know, these numbers skew one way or the other, depending on how expensive that market is, but you’re better off looking at the quality of the neighborhood than the total purchase price.

I’d rather be in a B, B plus a minus neighborhood, whether that’s 80,000, 110,000, $130,000, then to get a quote-unquote cheaper property in a C class neighborhood. Because I can tell you for a fact that my overall experience, 99 times out of a hundred is going to be much better. I’m going to feel better. I’m going to sleep better. I’m going to have a better experience, short term and longterm with those properties that are in better neighborhoods in good markets. Then focusing on those properties, cheaper properties that are in C class neighborhoods. I see them this so many times and there are other companies out there that are pushing so-called quote-unquote turnkey properties, but they really gloss over the fact that these are not in good areas, not necessarily the best renovations and the numbers might look great on paper, but you really need to question it, especially the condition overall condition of the property and what they’re budgeting for maintenance, repairs, and vacancy. And keep in mind if you are in C class neighborhoods budget more, much more for your vacancy allowance compared to be an A-class neighborhood. If you’re going to be class neighborhood budget a little bit more than you probably would for am A-class neighborhood. So you need to compensate based upon the type of neighborhood and the type of demographic you’re serving with your rental property.

Okay. I was talking real fast there. I thought this was going to be a five-minute episode. It was not, it was a 15-minute episode. So I apologize for that. Anyway, it’s a great question, Phillip. I hope this is going to help a lot of newbie investors and first-time investors.

I hope you enjoyed this week’s throwback Thursday episode. If you haven’t already, remember to subscribe so you don’t miss out on a single episode. If you have a question about real estate investing or finance, simply go to passiverealestateinvesting.com and click the Ask Marco button. I read all of them, I reply to many of them, and sometimes I cover them on the show, and I’m gonna try and do more of that. So, I am going to encourage you to go to passiverealestateinvesting.com and submit your question for Ask Marco. Lastly, help us share the show with other like-minded people that you know who can benefit from it as well. Just visit us on your platform. Most of you are on iTunes and leave us a rating and review. I would greatly appreciate it. I read them all and I will thank you in advance. And that is it for today. Thanks for listening. I will see you on our next episode.

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