One of the most, if not the most, important ingredients in a successful commercial real estate (“CRE”) investment is the property’s location and getting it right requires detailed knowledge about the supply and demand characteristics of the local market and sub-market. For this reason, we normally advocate for investing “in your backyard,” which is to only purchase properties in those markets and sub-market with which you are the most familiar. But, when trying to scale a business (in our case) or an investment portfolio (in an individual’s case), it isn’t always possible to stick to one market. So, on occasion, it can make sense to selectively pursue opportunities in “outside your backyard” or even out of state.
“Out of State” Markets – Defined
The formal definition of an out of state market is fairly self-explanatory, it is a market that is located in a different state than the one that the investor lives in. For example, we are located in New Jersey so any property that is not located in New Jersey is out of state for us.
But, informally, “out of state” can also be used as a euphemism for any property that is located in a market with which an investor is not intimately familiar, even if it is within the same state. For example, if an investor is based in Orlando, FL and they come across an opportunity in Miami, it is within the same state, but the market dynamics could still be foreign to them. So, perhaps a better definition is to define an “out of state” market as one with which an investor is not familiar.
Real estate markets are dynamic and ever changing, which means that some markets grow faster and present more attractive investment opportunities than others. As a result, there are occasions when they present a more promising risk/return profile so it can make sense to pursue them. For example, the Covid-19 pandemic has led to surging real estate demand in so-called “zoom-towns” (places like Maine, Tennessee, and Idaho), where individuals can find a balance of quality of life and price while working remotely. But, finding commercial investment opportunities in these places is easier said than done. On occasion, it can make sense for real estate investors to hire a local brokerage or real estate agent to help find commercial rental property. But before taking this step, it can make sense to perform due diligence on the local market for a number of key indicators of strength.
What To Look for in an Out of State Market
The most prominent challenge when looking for investment property out of state is lack of familiarity and lack of data. To that end, there are a number of metrics/indicators to look for when considering an out of state real estate transaction (NOTE: The specifics may vary slightly by property type. For example, a multifamily investor may prioritize Net Migration whereas an office building investor may prefer to look at job growth):
- Net Migration: There tends to be a correlation between the strength of a market and the number of people moving to it. For example, according to the US Census Bureau, the states with the highest numbers of net in migration from 2018 – 2019 are: Florida, Texas, Arizona, North Carolina, and South Carolina. It is not a coincidence that these states also contain some of the hottest real estate markets over the same time period.
- Jobs: People follow jobs. If a state is creating a high number of jobs, it is a promising sign that the market is strong. To illustrate this point, the Bureau of Labor Statistics publishes the states with the highest rate of job growth and it should be no surprise that there is some overlap with the states that have the highest numbers of net in-migration (Florida, Arizona, and Texas).
- Transportation: Strong out of state markets tend to have good to great transportation networks, which includes roads, highways, bridges, subways, airports, trains, buses, and dedicated walking/biking/running paths. The most attractive commercial properties tend to be located in close proximity to one of these transportation nodes, which allows for easy access to and from it.
- Wage Growth: Markets with strong wage growth tend to attract people who are looking to increase their earning potential, which in turn increases demand for the products and services needed to support a growing population, including commercial real estate. Wage growth statistics are published by the US Bureau of Labor Statistics.
- Supply & Demand: Like any commodity, real estate prices are a function of supply and demand. The more supply there is, the less likely it is that prices will rise over time. Conversely, if the supply is tight and the demand is high, it can be a promising sign of positive price growth. But, it can also be a sign that builders and developers will rush to build new space in response to high demand. On occasion, this can lead to an excess of supply, so it is important to review supply & demand from a historical perspective, not just a snapshot in time.
If the metrics look promising and the market appears to be strong, it is a good indication that the investment could be successful. But, these metrics only address half of the issue with out of state investments. Buying the property is one thing, but managing it is a completely separate challenge.
Managing An Out of State Investment
Aside from lack of market knowledge, one of the major risks/challenges to an out of state investment is that it can be difficult for an investor to manage because they don’t have any “boots on the ground” in the local market. To that end, it is common for some sort of local management partner to be utilized. In some cases, this may be a local property management company. In others, it may be an individual, like a real estate broker or property manager, who is responsible for managing the entire property. Either way, there are several things to look for when choosing one:
- Market Knowledge: The local management partner should be an expert in their given market. This means a high degree of familiarity with local property offerings, their owners, their rents, their demand, and their condition. This type of knowledge allows the local management partner to position the property effectively and ensure it stays occupied.
- Relationships: Managing a property is not a one person operation. A local management partner must be able to leverage strong relationships with lenders, brokers, tenants, vendors, and maintenance staff to ensure that the property stays occupied and runs smoothly.
- Legal Knowledge: Every market has different laws and regulations that a property owner must abide by when leasing their property. Some markets like Florida and Texas have relatively few rules while other markets like New York and California have many rules that must be followed. A good local management partner understands the law and works to stay within the bounds of it.
- Communication: Because the owner cannot be present on a day to day basis, good communication about the state of property operations is critical to the success of the investment. Communication with the local management partner can take a variety of forms including reports, emails, phone calls, pictures, and videos.
A good local management partner is an integral part of the asset management team and critical to the success of the investment. If they can be found, there are a number of benefits and risks to be aware of when making an out of state investment.
Benefits and Risks of an Out of State Investment
The primary benefit of an out of state investment is portfolio diversification. Because all markets are unique and some may perform better than others, having investments in multiple markets increases the chance that a well performing market can offset the underperformance of assets in other markets.
But, diversification comes at a price. Out of state investments increase the logistical challenges of managing a portfolio and require market-specific expertise to lease up at attractive rates. This risk is partially mitigated by having a local management partner who can act as the owner’s “eye and ears” on a day to day basis.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
We have many out of state assets in our portfolio and offer many out of state opportunities to our investors. If you would like to learn more about them, contact us at (800) 605-4966 or info@fnrealtypartners.com for more information.
