Making Big Profits in Small City Investing
Contrary to popular belief, you do not have to spend over 10 years of your life saving $200,000 to purchase your first investment property. There is an entire community of real estate investors who have built multi-million dollar real estate portfolios in less than 5 years, starting with less than $100,000 capital.
The secret is buying properties in small affordable cities where purchase prices are low and rental income is high. This allows investors to achieve higher returns and purchase multiple properties in a shorter timeline.
Investors often assume that large metropolitan cities like Toronto, New York, San Francisco are the most profitable places to buy real estate. However, this is not always the case. Investing in smaller cities often can be more profitable and stable. Investing in larger cities is often out of reach for The Average Joe for the following reasons:
- Expensive purchase price… High amount of capital required to start investing, typically over $200,000 to break into the market.
- Borrowing limitations… Investors with low credit or income will be rejected from obtaining large mortgages.
- Unscalable… Investors are typically only able to take out one mortgage which limits them to one or two properties.
The truth is for the everyday investor small city investing is often more profitable, accessible and scalable than larger cities.
Profitable: Smaller cities typically have a higher rent to purchase price ratio compared to large cities. The rent to purchase price ratio is real estate’s direct comparable to a dividend yield for the stock market. In other words, the rent to purchase price ratio determines how much dollars of rental income is generated for each dollar spent to buy the property.
Accessible: With lower lending and capital requirements and higher, jumping into small city investing does not require years of saving and is much more accessible for the everyday investor.
Scalable: Investors are able to purchase a property with significantly less capital required. A single property in a metropolitan area can buy two or three single-family homes in a small city.
Cash Flow Positive: Many small city investments generate rental income that is greater than the expenses incurred in the property. This is known as positive cash flow, a surplus of income over expenses.
Below is a comparison of two properties sold in June 2020 in both a small and big city.
Our small city property has a massive 13% difference in total return over our big city property. Taking a closer look at the returns, a big difference is where these investment returns are coming from.
- Small city property: ~25% of the total ROI is generated from rental income and principal paydown.
- Big city property: ~4% of the total ROI for large cities is driven by rental income and principal paydown.
In other words, the ROI for large city property investing is primarily driven by market appreciation. The problem with market appreciation is that it is speculative in nature. Market appreciation is heavily influenced by market supply and demand and investors have less control over their returns.
- Housing supply and demand is largely driven by government policy and external factors out of the investors’ control. For example, if the government stops all immigration tomorrow, demand for housing would fall.
A drop in property appreciation value will have a much greater impact on properties in bigger cities. If the price does not appreciate on either property, our one year investment returns in the small city property will drop down to 25% compared to 4% for bigger cities.
With smaller cities, rental income and equity paydown is more dependable and steady in nature. We can more accurately predict rental income, expenses, and calculate our mortgage paydown.
That being said, big city investing has its pros such as stability, long-term market appreciation, and high tenant quality. Big city investing has its merits and serves as a great way for investors to diversify their portfolio in long-term stable markets. Investing in larger cities have several advantages over smaller city properties:
Long-term Appreciation: Generally appreciation in larger cities are much stronger than smaller cities over the long-term due to population growth, job growth, tourism, desirability, etc. For investors who are looking for long-term returns (10+ years), properties in larger cities will likely appreciate at a greater pace than small cities.
Ease of Accessibility: Smaller cities lack the tenant quality you will find in large cities. Employment in smaller cities are less diversified and that could impact home prices and rent collection during a downturn. Bigger cities may prove to be less active than smaller cities due to the stronger tenant quality and ease of finding and replacing tenants during vacancies.
Small city investing is a great way for everyday individuals to enter into the real estate market without breaking the bank. The low barrier to entry and high returns allows investors to scale and diversify their real estate portfolio.
Start by finding the areas with the highest affordability near your city. Regardless of the city you live in, there is a high chance that there is another city within a 2-3 hour driving distance with affordable properties. BiggerPockets.com, one of the largest online real estate communities is a great way to connect with local investors or agents. Many of these community members are highly experienced with investing in small city properties.
While it does take some time to get all your ducks in a row, small city investing can be highly profitable and scalable for your everyday investor.
Austin Yeh is a real estate investor from Toronto, Ontario. He started exploring the industry after reading the classic book, “Rich Dad, Poor Dad” by Robert Kiyosaki. He is the Founder and CEO of the Rise Network, a not-for-profit platform for investors of all experiences to learn and invest alongside other real estate investors.
At the age of 25, Austin used his unique investment strategy to grow his portfolio to over 20 rental units. He earned strong and passive returns for his investors through his real estate portfolio with a focus on investing in Windsor, Ontario.
– Austin Yeh, Founder and CEO of the Rise Network
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