The “High Rent” City Exodus: A Pivot Guide for Real Estate Investors

by Guest Author, posted in Finances, Guides, Investment Strategy

This is a guest post from John, the founder of the Financial Freedom Countdown blog. John came from a third world country to the US with only $1,000 not knowing anyone; guided only by an immigrant dream. He accumulated a net worth of $2.3M in 12 years to be financially independent. He writes on a variety of topics related to increasing income, cryptos, stocks, bonds, real estate, alternative investments, life optimization strategies, protection against disaster and anything related to smart financial planning. John has been featured in Forbes, CNBC, MSN Money, Ladders, and more.

I have a confession to make. I am not a real estate investor. I am not a stock or bond investor either. I am a money investor. When I look at my net worth, it is distributed across stocks, bonds, real estate, cryptocurrency, art, business loans, etc.

A common mistake most real estate investors make is that they get married to an asset class. Or a particular strategy. And never change when the market conditions change.

Don’t get me wrong. I know that real estate is one of the best passive income-producing assets to own on a risk-adjusted basis. The ability to leverage, coupled with the favorable tax treatment, provides outsized returns for real estate investors. I own a primary and a rental in one of the most expensive cities in the U.S. Logging into my Stessa Dashboard when equity markets are volatile helps me sleep at night.

However, real estate suffers from a drawback. Investments in real estate are not liquid. Unlike other paper assets, you can’t liquidate your real estate investments at the click of a button. Also, government mandates at a local, state, and federal level makes it a tricky asset to own. Consequently, you need to monitor the current conditions of the real estate market in your local area and the broader macro trends.

Changing Trends Due to the Pandemic

As a result of the pandemic, two clear trends have emerged:

Trend #1: Urban Centers: Rent Drops and Outward Migration

The pandemic has resulted in the acceleration of technology trends. More and more people continue to work from home. Consequently, the rents have dropped drastically. This chart from Zumper shows the Top 10 priciest U.S. rental markets and the YoY% change:

Zumper Nov Rent Data
Zumper Rent Data

If you had purchased real estate with certain rent assumptions, would they still hold good going forward? What happens to the rents when the employers in your neighborhood start moving away?

Trend #2: Eviction Moratoriums: Federal and State Government

Some states are more tenant-friendly, and some are more landlord-friendly. This distinction was quite evident to real estate investors. I would be the first to admit that California, mainly the San Francisco market is not landlord-friendly.

The recent CDC moratorium on eviction meant that even landlord-friendly states were not immune. The entire experience made me risk-averse, and I talked about why a rental property is now a challenging investment.

A Pivot Guide for Real Estate Investors

Here are some steps you can take right now to reduce the loss of non-paying tenants or lower rent:

Step #1: Refinancing

The Federal Reserve has been lowering interest rates. Today we have low real yields comparable to high inflation periods and yet; a stable core CPI and low inflation expectations.

Mortgage rates have been the lowest in a long time. The 15 year and 30-year fixed-rate mortgages are quoted lower than during the 2008 housing crash.

Refinance any debt to lower interest costs. Although rates are not expected to rise, it might be better to lock any variable interest loans to the lower fixed-rate loans. If interest rates fall further, you can always refinance again.

Step #2: Tax Planning

Have a meeting with your CPA to explore additional tax saving strategies. A lot has changed in the tax code with the passage of the Tax Cut and Jobs Act from Opportunity Zones to QBI deduction for rental property.

In the past, when times were good, it was easy to overlook tax savings. But now, with reduced income, getting aggressive on your taxes could help your bottom-line.

Step #3: Out-of-State Rentals

Investors who have assets in high rent urban centers should consider the changing market dynamics. The move to smaller, rural, and suburban communities is a real phenomenon, and investors need to think about their options.

Companies moving to a remote working environment would lower the salaries by having the option of hiring workers in different geographies. As a result, the location premium of wages would reduce, and consequently, the rent would drop.

With companies being fully remote, they would no longer need to occupy office space in high rent urban centers. There are opportunities when companies set up headquarters in other geographies. In the past, I have relied on crowd-funded real estate. However, after losing money I have become better at evaluating real estate deals on crowd-funded platforms.

When Amazon first moved in, Seattle wasn’t even near the top of America’s priciest housing markets. Today, it is one of the top five housing markets. We can see this phenomenon play out when Amazon starts hiring for HQ2 in Northern Virginia.

Real estate investors like me who have always invested where they live; should be open to out-of-state rentals. Being a remote landlord comes with its own set of challenges, but we need to adapt. I plan to use my proceeds from the cash-out refinance to buy a few out of state properties.

Step #4: Furnished Rentals

The eviction moratoriums in most cities have not impacted furnished rentals. The furnished rental market consists of higher-income professionals. Often, the employer pays the rent, or the professionals need a place to stay before they buy their own house. Some of my best renters have been former home buyers who relocated here for a job.

Traveling nurses are another group of tenants who prefer furnished rentals. They have high paying jobs and employed in a recession-proof industry. Explore options to convert your rental into a furnished rental attracting a different type of tenant.

Step #5: Workshop and Maker-Space Conversion

A lot of individuals are now looking to diversify their income streams. Some individuals like my friend Betty have created an entire online business. Others opt for a combination of online and offline business, such as selling on Amazon, Etsy, etc. If your property has lots of storage space or can be modified to cater to these individuals, you could have options for a broader range of tenants.