The best cities to invest in for real estate all have one thing in common: a strong labor market. After a strong labor market, the best cities for real estate investing have low valuations, high cap rates, and a strong demographic shift.
As the economy recovers from the global pandemic and the lockdowns, the cities that will garner the most migration are the ones that are not highly populated, expensive cities like New York City. Instead, the best cities to invest in real estate will be cities like Charleston, South Carolina and Memphis, Tennessee.
Part of the reason why I bought a smaller house in 2014 was because I wasn't willing to rent my own house for the market price at that time of ~$8,500/month. The price to rent my house had grown from about $5,000/month when I first bought it in 2005. If I had a couple kids and a penchant for throwing tons of money away on rent, then maybe I would have stayed.
To optimize my finances, I figured the best thing to do was to buy a new house more suitable to my house-spending desires (~$5,000/month max) and rent out my old house at market to those willing to pay $8,500/month in rent. This way, economic waste is eliminated, and everybody is happy.
Conduct the same mental exercise with your existing home. If you haven't rented in a while, you may be surprised by how much your primary residence can command for rent in the open market. The cost of living in your home isn't the actual money you are spending to live there. The actual cost is the opportunity cost of not renting it out at market rate.
There is a great near-term real estate buying opportunity in your own city. Those areas in your city that are farther away from the city-center where most of the office buildings are will probably be more desirable due to the work from home trend.
If you plan to invest out of state, let me share with you why it's important to follow the real estate investment rule of Rent Luxury, Buy Utility if you want to maximize your lifestyle and your net worth.
Determining The Best Places To Invest In Real Estate
We can qualitatively say without prejudice that coastal city living can be considered Luxury living while non-coastal city (South, Midwest) living can be considered Utility living.
Who doesn't want to be near the ocean, see the ocean, fly direct to other countries, eat a wide assortment of food, be constantly entertained, and take advantage of the highest concentration of job opportunities? There's a reason why expensive cities are expensive.
But of course, non-coastal city people will balk at this classification given there's so much non-coastal city living has to offer too. There's something great to be said about a slower pace of living, much lower costs, and lots of space. We're all biased for where we currently live or where we come from. Therefore, the easiest solution to determining what defines Luxury and Utility is to utilize objective math.
According to data compiled by Zillow, the national Median Price to Rent Ratio is around 11.44 (see dotted horizontal line below) for 2020. Therefore, we can say the higher a property is valued above 11.44X annual gross rent, the more it is considered Luxury and vice versa.
If we use one standard deviation to determine the Luxury and Utility Median Price to Rent Ratio, the breakpoints are roughly 13.3X and above for Luxury and 9.6X and lower for Utility. In other words, roughly 68% of homes in America trade within 9.6X – 13.3X annual gross rent, which makes renting or owning a wash.
As you can see from the chart, San Francisco (Zillow includes Contra Costa and Alameda counties) trades at a Median Price To Rent Ratio of 20.51X, way above the 13.3X ratio I've determined to equal Luxury. However, my rental home trades at 26X annual gross rent, therefore, I should consider selling the property.
On the flip side, check out properties in Raymondville, Texas with a Median Price to Rent Ratio of only 5.2X. In other words, the median $60,000 house commands almost $1,000/month in rent ($60K / 5.2 = $11,538/year) . In other words, in just 5.2 years, you can have your renter pay back your entire property assuming you took out a 100% mortgage!
Raymondville, Texas clearly is considered Utility, and a savvy real estate investor should be buying Raymondville property all day long if their job market remains stable.
The problem is that access to the market hasn't really opened up yet. Not to worry though, since there are literally hundreds of other towns and cities with properties that trade below the 9.6X Utility classification ratio if you look at the Fundrise platform. It is one of the best investment opportunities post-pandemic IMO.
The Optimal Investment Lifestyle Combo
Of course, real estate is a very personal situation for each individual. We live where we want to live mainly due to our families, friends, and jobs. Not everything is about money. But given this is a site about ways to optimize our finances, a savvy real estate investor should seriously consider my advice of Renting Luxury, Buying Utility.
Here's a scenario I've been pondering now that I'm in the second half of my life. I want to be closer to my parents and live it up like a boss before I die.
For the sake of dreaming big, there's this sweet 5 bedroom, 5 bathroom, 6,400 sqft new construction home in Honolulu with a killer view asking $6.95M. Think how many sweet blog posts I can write from the pool!
Let's say the real price is $6.2M since it's been sitting for a while. Based on a 25X Median Price to Income Ratio, this means I can rent the house for approximately $248,000 a year or $20,500 a month. $20,500 is a lot of money, but think about how much rental income $6.2M can earn in Raymondville, Texas.
First, check out this picture and short video highlighting the $6.2M property. I'm happy to throw a pool party for readers who want to stop by and hang.
If the $6.2M was deployed in Raymondville, Texas, I could theoretically earn an insane $1,192,307 a year in gross rental income since the annual gross rent to price ratio is only 5.2X. After spending $248,000 a year living in a sweet home in Hawaii, I'd still have $944,307 left over in cash flow if I followed my rule of Renting Luxury, Buying Utility.
Seriously, the last thing I want to do is own a humungous house with tons of ongoing maintenance to deal with. But renting it is a different story. Besides, I don't have $6.2M laying around!
Real Estate Crowdfunding Investment Watch List
Here's a list of where you should be investing your real estate crowdfunding money based on fundamentals. The chart shows the share of homes in each city that can be rented out for more than their monthly expenses according to Zillow's database. Of course, you just can't buy every single property above the rental profitability line. You must still carefully run the numbers and do your due diligence.
The opportunities are plenty to buy cash flow generating properties around the country. The rise of real estate crowdfunding companies are making this move easier today. You just need to figure out what type of real estate portfolio mix you want.
For 15 years I've been 100% long luxury growth markets. Now I'm shifting towards a balance of growth and income (utility) because valuations are stretched in San Francisco and rental yields are 2X – 4X higher in the heartland of America.
If you can remove emotion, pride, and prejudice from the equation, you should be able to maximize your lifestyle, cash flow, and net worth.
Invest In Real Estate Crowdfunding
If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
The other excellent platform that focuses on commercial real estate in 18-hour cities is CrowdStreet. They allow investors to invest directly on the sponsor's platform.
Both real estate crowdfunding platforms are free to sign up and explore. I've personally got over $800,000 invested in real estate crowdfunding in order to simplify my life and potential earn a higher return.
