Have you heard someone say “the DOW is up 250 points today”? Or that is a specific stock has gone up $10 in the last year?
Well that sounds great, but how the heck am I supposed to know that that means without knowing where it started?
In the words of Einstein, it’s all relative.
What was the DOW at before and what is it now? What is the ratio or percent change?
It’s All About the Ratios Baby
Let’s look at an example to see why this is important. Let’s say you purchased 1 share of Dingle Enterprises at $10,000. And lucky you, it goes up 50 points!
Sweet, you made $50 with no work at all! But is that a good return?
Obviously you have to evaluate it based on how much money you originally put in … in this case your return was half a percent. Not so exciting now.
When we are evaluating rental properties, we won’t deal in absolutes (only a Sith deals in absolutes). We have to look at the ratios – in this case the rent to purchase price.
Look at Zillow for a home in your area and let’s evaluate if it would be a good rental. Here is one in my part of San Francisco. Every property has a Zestimate, which is the estimated sale price, and a Rent Zestimate, which is the estimated rent. Those numbers aren’t all that accurate, but they can give us an idea of the ratios. As of the time of this writing, the numbers for this property are $1,091,542 and $4,500.
Don’t be the idiot that says “wow, I get paid $4,500 every month for doing nothing? Awesome!” The ratio of rent to purchase price is 0.41%.
Or to put it another way, the monthly rent is about 1/243rd of the purchase price.
Ok, now let’s look at a random property in a market I would potentially invest in. Here is one in Atlanta. The Zestimate is $104,430 and the Rent Zestimate is $1,110.
The ratio for this is 1.05%. The monthly rent is about 1/95th of the purchase price.
Wow, see that difference? In terms of ratios, it is a 2.5x improvement!
If you think I cherry-picked these examples, go ahead and take a look yourself. Look up a property in your area and see the rent to purchase price ratio.
Expensive markets will reliably be below 0.5%. Areas with potential for cash flow rental property investing are reliably over 1%.
There is More to Consider
Don’t be the idiot that just looks at the numbers though. The area has to have job growth and new people moving there.
But this is a quick way to eliminate markets from consideration. Especially if you live on the East or West Coast, you’ll see you should look out of state.
Also don’t be the guy who says “if I drive just 2 hours to Stockton then the ratios are just about .1%” (or insert any podunk “suburb” where people generally don’t want to live).
Really? So you want not quite as good of returns in a town that is miserable with poor job prospects so you can spend your weekends driving there to keep an eye on it? Uh ok.
Don’t be the person who says “ya but the appreciation is better in San Francisco”. It could be. Or it could crash. Sounds a lot like gambling – you will probably be just as good at timing which color the roulette ball is going to land on. And besides, over decades the appreciate will trend equal to the more boring linear markets that keep chugging along.
An Investment, Not a Part Time Job
The numbers told me to invest out of state. The properties are also way less money, so someone can get started with just $20k rather than $60k for the cheapest properties a couple hours away from me.
But the thing I like most is that it helps me approach my rental properties as an investment, not a part time job.
If my properties were local (or even a couple hours away), I would likely be the landlord and way more active in maintenance. This would certainly save some money, but would not set up for long term success.
All those hours of work would weigh upon me and make me hesitant to add to my portfolio. At some number of properties (4?) I would probably not want to purchase another because I’m already devoting enough time to it.
With the out of state investing, my rentals are much more passive. Yes there is still a little time required with the property managers, but it is more scalable. I am not afraid of the on-going time investment with 10 properties.
More passive with better returns? Sign me up!
What do you think? Have you found investing in your local area more appealing than out of state? What are the ratios like?