Have you ever wondered the real world differences between local vs long distance commercial real estate investing? Is the "grass" really "greener" on the other side? Or are the best deals found in your own backyard? In this video, you'll discover the advantages and drawbacks of local and long distance investing as well as common pitfalls to avoid when investing in commercial real estate long distance:
Comparing Local and Long Distance Commercial Investing
Advantages of Investing Locally
If possible it is best to stay local when investing in commercial real estate. It’s simpler and has less risk. The truth is the grass isn’t always greener on the other side. Investing in your own backyard has several advantages.
Easy Access: When you want to keep tabs on the property, you can just get in the car and drive by.
Market Knowledge: You are familiar with the market because you live there. You know the trends, what's happening with vacancies, who's moving in, and who's moving out.
Demographics: It helpful to know who's renting your apartments and when you buy close to home you know the demographics of the area.
Landlord and Tenant Laws: Some areas have strict landlord-tenant laws that are especially pro-tenant. Navigating those laws as an investor can be difficult. By staying local, you know all the ins and outs of those strict laws.
Less Risk: Investing in your own back yard is easier and isn’t as risky.
Advantages of Investing Long Distance
Is it worth driving three or four hours, or flying to another state to buy commercial property? Well, there are advantages to investing long distance, especially if your market is too expensive.
Affordability: Investing long distance can be more affordable if you live in populated urban areas. Investors who live in big cities or in states like California benefit from investing in more affordable areas.
Larger Properties: In the larger urban centers you may only be able to afford a 5-unit multi family, whereas in more affordable communities you would be able to purchase a 12 unit or even 20 unit property.
Increased Cashflow: That means potentially higher cash flow and higher return on investment (ROI).
Build Portfolio Faster: By investing long-distance, commercial real estate investors can build their portfolio faster because they are able to purchase more property for the same amount of money.
The inherent risks of long distance investing seem obvious. You don't have easy access or know the area, and you have to deal with property managers from afar. On the other hand, the advantages make it seem like a no brainer. What investor wouldn't want more affordable properties and high cashflow? So, the question is, do the benefits outweigh the risks?
Pitfalls of Long Distance Investing
We teach our students how to invest locally and long distance. However, here’s a secret; some of our best student deals were purchased from long distance owners. Why is that? Well, these long distance investors eventually fail because of bad property management, their property is distressed, or it is just underperforming. If you are being priced out of your local market, then becoming a long distance commercial investor makes sense, but you need know what you are doing. Here are some of the pitfalls of long-distance investing.
In Over your Head: Long distance investors that fail invest beyond their knowledge. They thought the grass was greener on the other side. However, what they failed to realize is that the grass is only greener if you know how to mow the lawn. They didn't have the knowledge and wisdom to be successful.
Undercapitalized: One of the trends we’ve seen after years of purchasing properties from long-distance investors who fail is that they were undercapitalized. They just ran out of money and that’s because of their lack of knowledge. They failed to anticipate higher-level expenses. These investors didn't realize that when investing long distance there are different expenses compared to investing locally. There are varying weather patterns that require different maintenance expenses and different trends that cost more money. A lack of knowledge caused them to run out of money.
Poor Property Management: Another reason long distance investors fail is poor property management. The property manager ran their property into the ground. Managing the property manager is a skill. It's not taught in any book, it’s just not a subject that sells. But it is one of the most important skills you need to learn if you intend to invest long distance.
These three pitfalls, investing beyond your knowledge, being undercapitalized, and having poor property management, all led to great value-add opportunities for our students.
MOP Long Distance Investment Strategy
How do you turn these pitfalls into opportunities? The key is you must learn how to MOP a market. If you can't MOP a market, then don't do the deal. Let me explain. MOP stands for:
- Market Knowledge
- Operational Knowledge
- Property Management Skills
You must understand the market. Market knowledge includes knowing the property income and breaking it down per unit. For example, what the rent is for the one-bedroom, two-bedroom, and three-bedroom. You must also know how to value the property in order to determine what you will offer; you need market knowledge on what things are selling per unit in the area. So, the rent establishes your income and knowing the price per unit determines your entry point.
Lastly, you must know the market cap rate in the submarket you are investing in. To be clear, you need to know the market cap rate for the neighborhood you are investing in, not the entire city. For example, the city of Boston has several districts and each submarket in Boston has a different cap rate and that is the cap rate you must know. Knowing this will help you design your exit strategy.
Having market knowledge allows you to determine the income, what price to offer, and the exit strategy. These three pieces of information are critical regardless of the market you are investing in.
Not having an accurate picture of what the expenses are is why most beginning long-distance investors fail. They believe the numbers the seller or agent provide, and I can tell you those numbers are wrong one hundred percent of the time. There are always adjustments that need to be made. They're NEVER one hundred percent correct.
There are three areas of operations you must know:
Expense ratio – You must know the expense ratio for the area you are investing in. The expense ratio in Texas is different than California.
Expense Per Unit – You then breakdown the expense ratio to expense per unit. For example, Tennessee and Colorado operational expenses per unit are lower when compared to California because their utilities and taxes are lower.
CapEx: This term means capital expenditures. The CapEx budget is money you will spend on expenditures such as the roof, fixing the stairs, maybe replacing appliances, or putting in new carpet. These are the big ticket items and they do not include utilities, property manager, insurance or taxes. You must have an idea of what those expenses are, because if you don't they will come back and bite you in the behind. If you don't factor in that you'll need a new roof in three years and don’t budget for it, you will run out of money. So you must know what the capital expenditures are going into the deal.
One of the most important skills you need to learn when investing long distance is how to manage the property manager from afar. Once our Protégé Students close on a deal, we teach them this skill by having monthly meetings with them. We go over categories of the property, ensuring they're meeting their goals, the property is cash flowing, they're taking care of repairs, managing the management correctly, and keeping track of accounting. We cover what we call the four Ms:
Every successful commercial investment has a system to keep management accountable, money accountable, marketing flowing, and the maintenance going. Think of this as a four-legged stool. If one of the four legs start to fail, the stool becomes unstable. For example, if the maintenance starts to deteriorate on the property, how are the other three Ms affected? Well, if your maintenance starts to fail, it impacts your marketing. And if you can’t market your property, you begin to lose money and the whole system collapses. You can see why it is critical to know how to manage the property manager. Master this skill so that your long-distance investment doesn't become someone else’s opportunity.
My team and I mentor people to success with commercial real estate, whether local or long distance investing. Learn more here: Protege Program Details.