My thoughts on real estate investing are constantly evolving. Throughout the last 3 years, I’ve gained more experience and gotten to observe first hand all the caveats that are involved with landlording. Not only do I invest locally, but I also own a few properties out-of-state, so my datapoints are varied.
There are definitely pros and cons associated with both approaches, and yes, you can make money with either one (or both). The purpose of this post isn’t to debate in-state investing vs. out-of-state investing, but rather, I would like to share with readers my current state of mind and gameplan moving forward.
Not too long ago, I wrote an article stating that my goal was to purchase 10 rental properties by the end of 2015. Well, just like always, time moves at a blistering pace, and lo and behold it’s now already Q2 of 2015! Currently, I have an ownership stake in 8 properties, and 10 units total. So, that original goal set in 2013 is still definitely within reach…
Back then, my preference was to invest out-of-state because my primary focus was to build up cash flow. I still believe that cash flow is of paramount importance, but these days my preference has shifted to focus more on Class A properties.
And here’s why:
Class A Properties
By definition, Class A properties represent high quality. You don’t get to qualify just any property as Class A, and the ones who are lucky enough to receive such a designation (although arbitrary) usually possess some form of the following: Located within a wonderful school district, nearby a plethora of jobs, beachfront property, in the heart of downtown’s hustle and bustle, etc.
With Class A properties, you expect a good degree of appreciation. Not only that, but Class A properties are always in high demand, by both homeowners and investors. Really, when it comes down to it, there are only two drawbacks to investing in Class A properties:
- Barrier to entry is high. These properties are expensive so you need lots of $$$.
- Cash-on-Cash (CoC) Returns are low. If it’s cash flow you are aiming for, it will be dismal (or negative) in Year 1.
For these reasons, many real estate investors shy away from Class A properties, and instead choose to invest in properties that pack “more meat on the bones”. When I was heavily cash flow focused in 2013, that was my exact mentality and the reason I strayed away from the Bay Area.
In hindsight, I don’t have any regrets, as I feel that my out-of-state rentals do provide good diversification into my overall real estate portfolio. I went hunting for more cash flow, and indeed I did manage to locate that out-of-state! 🙂
Nonetheless, my current preference is to focus primarily back in the Bay Area again because I strongly covet adding more Class A properties to my portfolio. I do realize that this isn’t an easy task… The downpayment required to win a single Bay Area property can tie up enough funds that you could instead purchase 4 out-of-state rentals in Class B/C neighborhoods. Yes, from a cash flow point-of-view, the 4 of-of-state rentals would wipe the floor with any single Bay Area rental…
But I would still make the decision to go with the Bay Area property, today, because of the many “hidden” benefits associated with Class A properties. Recently, I finished remodeling Rental Property SH #3, and just posted a local ad to gauge market interest.
Here’s what I got on the first day of listing:
We are very interested in viewing your home for rent. We are ready to move in anytime and have rent and deposit readily available. Good references and income as well as money in the bank. The home will be for two adults and one child. I work for a property management company and have for the past 12 years. We are responsible tenants and will ensure your property is properly maintained, as well as timely rent payments. Please contact us as soon as possible. We appreciate your time.
Now, I can’t say for certain how this applicant will turn out… but it’s a very promising start so early on in the tenant search. To be perfectly honest, my listing is also above market rent… so I was just taking a flyer more than anything else…
I’m sharing this datapoint with readers because this is the type of education I had to learn myself over the past 3 years as a landlord… This is an oversimplified explanation, but in a nutshell, with Class A properties it’s very much a logical give and take relationship:
Quality home = Quality tenants
With my first two rental properties, I’ve always collected rent on time each and every month, and the tenants are more than self-sufficient. Respect given is reciprocated with respect received… Just the way it should be! With my Class C properties, I’ve had situations where I rented out a fully rehabbed turnkey property to a tenant, and within the first two months, they stopped paying. In Indianapolis, for example, I had my first eviction before even the half year mark! Go figure…
Again, you won’t see these hidden benefits of owning a Class A property show up on a Pro Forma or Excel spreadsheet… But I’ve learned to stop always chasing after the projected $$$ and to instead focus on winning the highest quality tenants. If you can secure that, you can easily self-manage and set your monthly PM fee to $0. Further, vacancy can very realistically approach 0%… These non-costs do add up over time and translate into real, tangible cash flow!
As investors, we are all searching for peace of mind. Who doesn’t want to own assets that allow them the ability to sleep comfortably at night, sound like a baby with no care in the world? Class A assets will give you as much peace of mind as any investment possibly could.
Within my own portfolio, my Bay Area properties are the ones that I least worry about. This goes for Rental Property #1, Rental Property #2, and so far both SH #1 and SH #2… Over time, I would love to add SH #3 to that list as well. For the most part, that entire portfolio runs on auto-pilot, and I simply kick back and collect the rent checks. I know I’m making it sound almost entirely too effortless, but I would be lying if I said otherwise…
And all these datapoints are the ones nudging me to keep on investing in the Bay Area. With these properties, I get a good blend of the following: appreciation, cash flow, quality tenants, easy exit strategy, and the ability to self-manage to reduce expenses. If it ain’t broke, why try and fix it?
When it comes down to it, I’m not saying you have to ONLY invest in Class A assets. I don’t believe in binary numbers (or thinking), and I can never for the life of me figure out why some people feel like they can only play for ONE team. You can also own Class B and Class C properties… Why not? I’ll agree with you 100% that Class B and Class C rentals cash flow better than Class A… Actually, I wouldn’t mind owning some more Midwest cash cows, even as we speak, and I may very well pick up some more in the future…
So sure, I’ll definitely dabble in other spaces and allocate a portion of my portfolio to different types of assets, but at the end of the day, I know that the bulk of my portfolio needs to be concentrated on Class A properties. The anchor to my investment portfolio needs to be strong (for future sake), so if I’m going all in, it’s got to be with Class A rental properties.
Over the past 3 years I’ve learned a few things… Previously, I was hell bent on chasing after cash flow. Now, I’ve realized that I need a supremely sound anchor in place FIRST.
Cash flow can come later… Even with less of it, I have a feeling things will work out A-OK as long as I keep on stockpiling some high quality Class A rentals!