Real estate investors on U.S. coasts target cheap, out-of-state markets

NEW YORK (Reuters) - Even with a good salary as a data scientist at a San Francisco technology firm, Yang Guo, 30, knew he couldn’t afford a home in the Bay Area, among the priciest U.S. markets.

A home in Lexington, South Carolina, that was purchased earlier this year by San Francisco-based investor Yang Guo through HomeUnion as an investment is seen in an undated handout picture.Home Union, Inc/Handout via REUTERS

He still wanted to own property in addition to stocks, however, and soon found a way to buy cheap rental houses in faraway cities - and to outsource the associated hassles to HomeUnion, a three-year-old startup in Irvine, California.

The firm is among a small crop of new companies, including competitors Investability and Roofstock, that offer ways to buy, renovate and manage properties in markets that command relatively strong rents compared to their low home prices.

The risks remain the same as any landlord faces, from vacancies to broken appliances to the potential for a rent- or home-price downturn. And using such services places a lot of faith in young companies with short track records.

But the firms, launched after the housing crisis, say they can take much of the worry and work out of owning out-of-state rentals, for fees that typically run from 7 percent to 10 percent for property management and 3 percent for acquisition. Their clients usually buy one or two homes to supplement their incomes and investment portfolios.

The companies are pulling in money from clients in costly coastal markets that is boosting demand and home prices in the lower-cost cities they target. “In the last 12 months, I’ve seen more cash buyers from California than I’ve ever seen in my career, and I’ve been doing this for 25 years,” said Anne Callahan, a real estate agent in Cleveland, Ohio, where the average rent for a single-family home is up 4.2 percent over the last year, according to Zillow Research.

Earlier this year, Guo bought and fixed up a small home in the suburbs of Birmingham, Alabama that he found through HomeUnion. He purchased another home in the suburbs of Columbia, South Carolina - spending about $60,000 on the pair.

Now, from his apartment in San Francisco’s trendy South of Market neighborhood, Guo collects monthly checks from tenants he has never met in properties that he has never seen, all located more than 2,000 miles away.

“There’s too much risk with buying property in the Bay Area,” Guo said. “As long as the cash flow is coming and hitting my bank account, I basically don’t care about seeing them in person.”

Buyers like Guo are attracted to less glamorous regions where home prices and rents have risen at modest rates in the housing recovery. They’re eyeing steady income rather than rapid home-price appreciation.

In suburban Atlanta, the average landlord of a single-family home reaps a 25.8 percent gross annual yield, a measure of annual rent divided by median sales price, not including other potential costs, according to real estate data firm RealtyTrac. That compares with just a 3.4 percent yield in the San Francisco Bay Area, where the median home price was $675,000 in August, according to data provider CoreLogic.

“It’s all people from the coasts coming to us and saying, ‘We want to find a way to buy properties out of state,’” said Don Ganguly, the chief executive of HomeUnion. LEARNING TO BE A LANDLORD

Most homes purchased through the firms go for between $50,000 and $150,000, the companies said, or about typical for first-time home buyers in the same markets.

Florida has long been the most popular state for out-of-state investors, in large part because of its beaches, but lower-priced states such as Georgia, Tennessee, and Ohio are emerging as destinations for buyers from beyond their borders, according to RealtyTrac.

For a graphic showing top markets for out-of-state landlords, see:

While these investors have identified a real opportunity, their inexperience and lack of local market knowledge can lead to some mistakes, real estate agents said.

“You see these people coming from California and what I like to call ‘yuppie-ing up a place,’ but they don’t realize it’s not in the best area because they didn’t do their homework,” said Tony Kazanas, a real estate agent in Cleveland.

Guo, the San Francisco investor, had no experience as a landlord and is already realizing that it is not as simple as he imagined.

His property near Birmingham – in a metro area whose 14.4 percent vacancy doubles the 6.9 percent average nationwide - sat empty for a few months before he landed a tenant. The high cost of property insurance, meanwhile, is making him wary of buying in areas susceptible to hurricanes and other natural disasters.

There are signs, too, that the rental industry is cooling off. After the housing crash, hedge funds raced into beaten down markets including Las Vegas and Los Angeles, buying up large blocs of single family homes to rent out. But some institutional investors are now eyeing an exit strategy. Blackstone Group LP’s Invitation Homes announced in July that it expects to sell about 5 percent of its about 50,000 homes to current renters.

In addition, while U.S. rents have risen by an average of 4.1 percent since 2010, average rents in New York, San Francisco and San Jose fell in the third quarter for the first time during that period. The decrease in expensive markets could presage broader weakness rent prices nationally.

BUYING WITH RETIREMENT FUNDS Many investors still see a long-term play. They are turning to self-directed individual retirement accounts, which allow investors to buy property and let their rental income build tax-free as long the home is kept for investment, not personal use. Some buyers use their IRAs to pay cash for rental properties, but others get mortgages from niche lenders that offer them on properties held in retirement accounts.

“Self-directed IRAs are becoming a more critical piece of property sales as an investment,” said Dennis Cisterna, chief revenue officer at Investability. Major asset management firms like Charles Schwab and TD Ameritrade do not allow account holders to buy property directly using their IRAs. Smaller firms such as Oakland-based The Entrust Group, which manages about $2.2 billion in assets, say that about a third of clients use their self-directed IRAs to buy real estate, with Kentucky, Alabama, and Arizona among the most popular markets for California-based clients. Guo, the San Francisco investor, used cash savings and took out a mortgage on each property. The monthly notes for both houses total less than what he pays in rent in San Francisco, he said.

He takes some of out every paycheck and earmarks it for real estate, hoping to build a portfolio of at least 10 rental properties for less than what it would cost to buy a single home in the Bay Area.

“There’s nothing like the competition that you see in San Francisco,” he said.

Reporting by David Randall; Edited by Dan Burns and Brian Thevenot